Policy, Research, andlxternal Affairs
WORKING PAPERS
Trade Policy
Country Economics Department
The World Bank
August 1990
WPS 463
Redefining Government's
Role in Agriculture
in the Nineties
Odin Knudsen and John Nash
with contributions by
James Bovard, Bruce Gardner, and L. Alan Winters
The legit niate roles of' sovernnment in a-riclultUre - especial lv
investnient and research have ot'teni been subordinated to P
roles tor which ;overnnlient has shown little collipetence, such
ais price setting and intervention in mnarkets. These prioritie's6 \t
miuLst be reve rsed. 11o
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Policy, Research, and External Affairs
Trade Policy
WPS 463
This paper-a product of the Trade ioliy Division, Country Economics Department -is part of a larger effort in
PRE to invesLigate the impact ol' indusLrial mountry pol icy on deve loping countries and how impedimcnts to structural
adjustment in the latter countries can bcst be removed. Copies of this paper are available free from the World Bank,
1818 H Street NW,Washingion, DC '(43 3. Pleaise contact Karla Cabaina, room N I0-037, extension 37946(122 pages
with tables).
Government policies in agriculture have been costly to avoid reciprocity in trade policy reform and to
and misdirected worldwide, argue Knudson and Nash. protect infant industries or use quantitative restric-
tions for balance of payments purposes.
In developed countries, those policies have cost
taxpaycrs and consumers hundreds of billions of' * Get all countries to reform their agricultural
dollars yet failed to provide low-cost food while policies, to reduce the many policy-induced distor-
sustaining farm incomes. They have disrupted world tions that plague the sector. Measures that need
trade and could create divisive trade coonilicts with reform include import restrictions, export subsidies,
ramnifications well beyond agriculture. They cnrich and dumping of surplus commodities by the OECD
larger farmers and agroindustrialists and probably countries; and subsidies to fertilizer, irrigation, and
accelerate the replacement of the fainily farim w\ith the credit that distort trade incentives in both developed
large farm business. In thc long run they have and developing countries.
contributed to degradaltion ol' the environmClt.
Such a bargaini would result in a redel'inition of
In developing couintries. those policics h ve uovereillients' role in agriculture, increased sectoral
impoverished rural people ,ilhouLt prov idiing the f'oo(d efficiency nationally, and a more smoothly function-
security urban consumers andl polrcs nnuker s want. ilnc and lightly knit world agricultural trading system.
Immense funding wasled on subsidies of' lertli/er,
credil, andi urban consumers shoUld ha..\ c been Mlany Of the unproduclivc policies deLailed by
invested in areas wher, prkate markets do not w\ork Knudsen and Nash have a coimmon cause, they say:
Ncil because the costs or benefits are dil'licullt tO eov\ernments' tendency to see problemils as resolvable
initcrnalizc l'or private agents - - inlIrastructurQ or by taking incomiie trom somile and giving it to others.
sonie basic research, lor e.\anmple. What is needed, they say, is to reconsider the
government's proper role in agriculture -- and the
'This inelficienc\ need.l not ontinuc, argct inslitutional changes that would follow from that.
Knudsen and Nash. 'I'he L.ruguay RouLn(d is an1 ideal Knudsen anLi Nash are specific in their suggestions
opportunity lor dcveloped and dle eloliillg na1tions to i'or change.
strike a bargain, the clements of wn hihti stoLil(d be to:
Resolving the problemis in agricultural policy
MNake agricultural trade subject to the lull requires withdrawing most goverrmcnt intervention
discipline Of the GA-1 by eliminating w\aivers andl frorn agricultural markets and recognizing economic
exemptions that ha\ e set aericultural comrmnodities righits: the farmers - to produce whatever commo(ii-
apart from other products in their treatmient under the ties they f eel will profit them best and scil them freely
GATT, at home or abroad: the traders - to move goods in
expectation of profiLs, without fear of reprcssion: antid
* Bring developing counLtrics fully into the CGATF' consumers - to buy foods at the lowcst prices, f'rotn
by eliminating their spcial1 stLIats w hic h allows st heim foreign or domesLic sourccs.
he Il'RE Working l SPrl< hcri"', J th' fi:! f . kwrk undcr v.;I\ in the Rank's l\olicv, Rcsearch, ant External
Affairv ( .An bk4 ( l' . rac s . t iK's ! n4hng'. our kl! . es en if Apresenilons ;tre less thant fully T˘lishe
The' findingys, mntTrrc¶.t. on, Xid ItWit wi ' ii' : lk l jtf 'xn !lT not nTc sslaril\ reptresent official Bank potic\
PI ,1-, Iv< '\ O'!t' I'RIl 1)COlll l(TIItr
Redefining GoverTnent 's Role in Agriculture in the Nineties
by
Odin Knudsen and John Nash
with contributions by
James Bovard, Bruce Gardner. and L. Alan Winters.
Table of Contents
Chapter 1 The Government and Agriculture 1
Is Agriculture Special, So Special So As to Need Heavy Goverrunent
Involvement? 3
Chapter 2 The Morass and Consequences of Industrial Country Agricultural
Policies 9
1. United States' Farm Programs 10
i troduction 10
The Evolution of United States Policy 11
United States Methods and Levels of Support 18
Grain Policies 19
Other Commodities 23
Costs and Consequences of U.S. Policies. 1984-89 28
11. The European Community's Common Agricultural Policy 38
The Evolution of EC Policy 38
The CAP -- Methods and Levels of Support 39
The Domestic Costs and Consequences of the CAP 43
The Foreign Costs and Consequences of the CAP 50
111. Japanese Agriculture Subsidies and International Trade 53
Chapter 3 Government Intervention in Agriculture in Developing Countries 58
1. Parastatal Marketing Organizations 61
Pricing 62
Management and Operation 68
Reforms 70
II. The Questionable Goal of Price Stabilization: The
Government's Role in Output Markets 73
Objective of Price Stabilization 73
Trade Policy 80
iI
III. Subsidizing the Large Farmer: The Government's Role in
Input Markets 84
Fertilizer Subsidies 84
irrigation 87
Credit 91
IV. Subsidizing the Present with the Future: Effects of
Government Policies on Public Investment (or How to
Make Pork out of White Elephants) 95
Chapter 4 Redefining the Role of Govemment in Agriculture 99
Redefining the Role of the Government 100
Strengthening GATIT and Agricultural Disciplines 107
What Needs to Be Done: The Bargain 114
References 117
Odin Knudsen and John Nash are economists in the AGRAP and CECTP divisions.
respectively, of the World Bank. James Bovard is a policy analyst with the Cato Institute.
Bruce Gardner is a professor in the Department of Agricultural Economics at the University of
Maryland. L. Alan Winters is a professor in the School of Accounting, Banking, and
Economics at the University of North Wales.
CHAPTER 1
THE GOVERNMENT AND AGRICULTURE
Agricultural policy in developed and developing nations is a tangle of
contradictions. Throughout the world, governments have "one foot on the
accelerator and one foot on the brake"--simultaneously encouraging and
discouraging increased farm production. 'n the United States, the governmenL
is pressuring many farmers to leave good farmland unplanted--while paying other
farmers bonuses of 50 percent over market prices to boost their production. In
Europe, if farmers produce more than a government-set limit, they are penalized
by reductions in their government-set prices. In many African nations,
governments refuse to pay farmers the true value of their crops, yet sell farmers
fertilizers and seeds for far less than they are worth.
At a time when East European economies are moving rapidly away from central
planning, many agricultural policy makers in industrial countries show little
sign of a willingness to deregulate and de-control the production of food. Yet,
programs that were begun with a rationale of avoiding food shortages are now the
primary cause of cutbacks in production and the wasting of food. In both the
United States and European Community, the more generous governments have become
to farmers, the more controls governments have imposed upon farmers. And
unfortunately, the United States and European Communities have set precedents
that are encouraging other governments to increase their controls over their own
farmers.
While developed nations have been squandering their agricultural resources,
developing nations have been squandering their farmers. In much of Africa,
farmers have no right to market their crops on their own or to bargain with
buyers for a fair price. The government buys their crop at less than world
2
pr'ces and sells it for even less to relatively better-off urban dwellers.
Farmers have been arrested and punished simply for seeking to sell their own
grain. Agricultural restri:tions and controls frequently drive down the market
price of food. Farmers usually react to suppressed prices by reducing their
production--which results in perennial shortages, repeated famines in sonme
nations, and the need to seek imports or food aid. Regrettably, many
politicians have reacted to food shortages by imposing new government controls
on farmers and markets and creating more inefficient govsrnment enterprises,
rather than abolishing the controls that caused the original problem.
Farm programs in developed countries are costing taxpayers and consumers
between $200 and $300 billion a year (Goldin and Knudsen). The aggregate costs
of developing countries' p licies is less well known, but estimates place the
net benefits to developing countries from more liberalized agriculture at about
$60 billion per year (Anderson and Tyers). In industrial countries, annual farm
subsidies ex:eed the total World Bank lending since 1980, and the total IMF
lending since 1970; annual subsidies also exceed the total amount of development
aid given to sub-Saharan Africa since 1980. Farm programs have been allowed
to become so costly partly because programs are so complex and the costs so
hidden and diffuse that few people realize their true magnitude. One recent
study estimated that the effects of existing farm trade barriers amounted to a
tax of 233 percent o0i sugar by the United States and of 421 percent on dry milk
by the European Community. It is not unusual to find in developed countries a
hidden tax on consumers from agricultural trade barriers of 50 to 100 percent
on basic food grains. In developing countries, costs also ar, hidden, with
relatively well-off urban consumers eating food subsidized at the expense of much
poorer and hungrier farmers.
3
This costly intervention in private production and marketing is
unjustified; in both de eloped and developing countries it benefits primarily
the relatively well-off. This massive level of misguided government intervention
in agriculture has no precedent in any other sector of the economy. If such
policy were found in social welfare programs, say for the unemployed or homeless,
it would be a major scandal of waste and misuse of government power. Yet this
intervention continues, misusing taxpayers' and consumers' money to support
relatively few farmers and taxing farmers in developing countries under mistaken
notions of what agriculture is really about and what governments can actually
accomplish in the farm sector. Furthermore, the dev-loped nation farm policies
have spilled over into the international markets, disrupting trade and taking
income producing opportunities away from much poorer farmers in developing
countries. In 1986, the World Development Report described the abuses and costs
of these misguided agricultural policies. Unfortunately, farm programs have not
been fundamentally reformed. At the time this report is being written,
governments are meeting in Geneva in the Uruguay Round of trade negotiations,
attempting to reduce governments' heavy intervention in agriculture. It is hoped
that this report will assist in pushing the negotiations forward to a resolution
of this incredible mismanagement of human and natural res^urces.
IS AGRICULTURE SPECIAL,
SO SPECIAL SO AS TO NEED HEAVY GOVERNMENT INVOLVEMENT?
Agriculture is unique in economies. Farm sectors comprise highly
competitive businessmen, producing a relatively homogenous commnodity for sale
in a market with numerous, price and quality conscious consumers. In other
words, agriculture would appear to be the ideal industry in which to realize a
4
textbook-perfect competitive market to the benefit of both producers and
corsumers. Consideriag the potential fcr pervasive competition and lack of
market dominance by any one producer, one would think that agriculture is the
least likely sector of the economy to find extensive government intervention.
But throughout most of the world, governments are dominating agriculture.
For instance in the United States, there is one government bureaucrat for every
three full-time farmers and the budget of the Department of Agriculture exceeds
the net income cf all farmers together. In Europe, two-thirds of the budget of
the European Commission goes to support farmers. In developing countries, nearly
every government owns an enterprise which monopolizes the trade of at least one
major agricultural commodity. The heavy hand of government disrupts the
international markets for many major crops through intricate barriers to trade
and subsidized dumping of surplus commodities.
Why is this? One reason is that farmers are politically organized.
Throughout the world farmers have formed lobbying groups--even in remote areas
of India or in the coast of Ecuador. But now! ? are they as well organized as
they are in the United States, Europe or Japan--the havens of the world's largest
government handouts for farmers. It is widely recognized that two of the most
powerful lobbies in Washington are the dairy and sugar associations. In France,
farmers routinely go on strike and seek to close down major highways until their
damands are met. In Japan, the backbrne of the Liberal Democratic Party, the
party that has ruled Japan virtually ever since the end of World War II, is the
farm lobby. Farmers have a political voice that often makes politicians and
policy makers support unwise and costly farm programs. As a consequence, most
farmers in developed nations receive for their commodities prices that are
higher--sometimes six times higher--than those in international markets. In
5
fact, international markets have become the dumping ground for farm products
that cannot be sold at home.
Ironically, around the world, food is .heap--that is, if your country does
not produce the particular imported food. Food is much cheaper in Hong Kong
than in Japan--primarily because Hong Kong has almost no farmers. The curse
of the consumer in the 1980s is to live in a country self or r.early self-
sufficient in food--for it is almost a certainty it will cost more in countries
where it is produced (particularly developed countries) than where it comes off
a ship. Historically, the greatest beneficiaries of United States and European
Community farm programs have been the food importing countries, especially the
USSR and Eastern Europe, and the lesser developed countries, especially in
Africa, which unfortunately have taken advantage of cheap imported food whiie
undercutting the development of their own agricultural sectors.
But the strength of farm lobbying groups is not the whole reason for farm
policies being so costly. People in general are concerned about adequate food
supplies. Most people in the world have occasionally experienced hunger, and
some, perhaps a billion, for all their (shortened) lives. Even today in a world
filled with food surpluses and waste millions of children die of malnutrition
or a disease related to it. No one wants to wish hunger or death on anyone.
Isn't then a little food security and over-production justified?
It would be wonderful if food production could end hunger in the world.
If it could, hunger would have ended in 1986 when the world over-produced
millions of tons of cereals, of meat, of dairy products, and of high calorie
sugar. Surpluses accumulated in government stocks despite the government paying
for millions of hectares of land to be set aside from production, wnile surplus
6
milk was fed to calves and government bureaucrats rewarded farmers for killing
two million cows in order to reduce milk supplies.
The world has had petaistent grain surpluses for most of the last thirty
years. If hunger were caused by insufficient food production, then the problem
of hunger could have been solved long ago. Rather, hunger is overwhelmingly
the result of poverty--of not having money to purchase widely available food
supplies. The solution to the problem of hunger is largely the same as that for
poverty--it is capital to build infrastructure, research to yield new
technologies, education and health care so people can be more productive and
viable economies promoted by stable and sound fiscal and monetary policies. In
other words, it is income growth along with health and targeted nutrition
programs that is largely the long term solution to hunger and malnutrition.
Hunger certainly cannot be solved by food production promoted by expensive
subsidies and wasteful trade protection. That is one of the clearest lessons
of the last few decades.
But what about the future? Will farmers continua to produce sufficient
food to create surpluses? The dominant factor in agricultural economies in the
past century has been the declining real prices of food. Crop market prices
have consistently fallen in r -l terms because the cost of production has
plummeted. Mechanical inventions, the development of new seeds and fertilizer,
the development of sound management techniques on the farm, and the success of
private and government-funded research have all helped drive down the cost of
food production. Unfortunately, politicians have long tended to view falling
food prices as an economic problem rather than as a natural and inevitable result
of technological progress and an opportunity for more citizens to have a better
diet. And the political responses to falling prices--pushing massive subsidies
7
and requiring productive land to be idled--have reduced farming efficiency
through keeping unviable farms in business, and destabilized agricultural
markets.
In the past two decades, technology in plant breeding has experienced the
greatest advances in the world's history. Wheat yields have increased by 36
percent since 1974; rice yields by 38 percent; and coarse grains by 30 percent.
In the United States milk production per cow is increasing three to four percent
per year. Since 3970, the PAO's food production index has increased by over
45 percent in part because of this technological revolution and in part because
of the rapid growth in fertilizer use and the increase in irrtgated area by
around 30 percent. The Unittd States Congressional Office of Technology
Assessment estimates that yields of major crops could increase by 20 percent by
the year 2000. And further advances in biotechnology promise even greater
advances. All major crop plants are amenable to significant yield increases from
biotechnology. Advances in biotechnology for animals are already here. Use of
hormones in pig production can cut feed requirements by 25 percent, saving 30
or 40 million tons of feed. Hormones in dairy and meat production can save even
more in feed grain use and increase yields greatly, but their use has been
constrained by health concerns, some perhaps well-founded and some not.
Furthermore, developing countries currently use very small quantities of
purchased inputs in their food production. Potential expansion in yields in
developing countries from moderate _ vels of input use or extended irrigation
is enormous.
And so it continues--technology pushes forward productivity gains, forcing
downward real producer prices. Antithetical to this economic progress,
Government programs attempt to artificially support farm prices. Hence, the
8
root of the dilemma--progress against the resistent forces of fanm support
programs. The results are surplus accumulating under government ownership and
idle productive capacity.
This does not mean that there are not constraints to agricultural
production. Soil erosion is a serious problem in some parts of the world and
does affect localized production. Increasing productivity in fc,od production
in Africa remains the greatest challenge in agricultural development In the
world. And carbon dioxide is increasing in the atmosphere at a very rapid rate.
Furthermore, misguided agricultural policies in both industrial and developing
councries are causing destruction of the environment through abuse of water,
fragile soils, fertilizers, pesticides and otherc chemicals. But these problems
should be separated from the overall issue of w'nether the world can feed itself
(which it can) ard whether there is a need for extraordinary intervention by the
government.
Drastic reform of agricultural policies is desperately needed in both
developed and developing countries. In developed countries, governments must
recognize the futility of attempting to oppose the fundamental economic tide of
technological change and recognize the environmental destruction reaped by
current policies. In developing countries, governments must allow farmers to
freely market and trade their agricultural products. They must end policies
that lead to salinization and de-forestation, many of whic'. az.e followed under
the misleading banner of fooa security. The political realities appear to
require that this reform take place in a coordinated manner, through
international negotiations such as in the Uruguay Round. The purpose of this
report is to promote these agricultural policy reforms by documenting the waste
and distortions caused by current farm policies and to redefine a more
appropriate role for governments in agriculture.
9
CHAPTER 2
T' MORASS AND CONSEQUENCES OF INDUSTRIAL COUNTRY
AGRICULTURAL POLICIES
In developed countries, rapid advances in agricultural production
technology have vastly increased the productivity of farm labor and, therefore,
greatly decreased the number of farm laborers needed. New technology has also
resulted in a steady decline in the cost of production and a decline in crop
price>. These factors, along with increasing opportunities in urban areas have
combined to create a strong incentive for rural-urban migration. This came to
be seen by governments (spurred on by the farm lobby) as a process with dire
consequences for the future of a stable society. So, instead of trying to make
the transition as painless as possible, governments have perennially tried to
artificially increase the number of people remaining on farms and to support
their incomes. Governments have pursued this goal by prohibiting free
agricultural trade in international markets, by imposing de facto taxes on
consumers through higher prices, and by spending taxpayers' income on farm
welfare programs. The results have been the same as those from other efforts
to restrain the flow of fundamental economic tides behind regulatory bulwarks.
The bulwarks--in this case, trade controls and income transfers--have of
necessity been built higher and higher, and, as a consequence become more costly
and distortionary.
According to OECD estimates, thesn farm program bulwarks have risen to
well over $200 billion a year in the OECD countries alone. In this chapter, we
will review for the three major subsidizers of agricultural production--the
10
United States, the European Community and Japan--the evolution of their programs
and how they have distorted both domestic and international markets.
I. UNITED STATES' FARM PROGRAMS
Introduction
For over 50 years, American farm programs have provided large benefits to
large farmers and small benefits to small farmers. Yet, the farm lobby has
succeeded in persuading the American public that the programs exist to preserve
the relatively small family farmer. As a result, the U.S. in the 1980s has
essentially the same farm programs that it had in the 1930s.
The General Accounting Office, the premier audit agency of the federal
government, has produced scores of reports detailing waste and ineffectiveness
in farm programs Yet, federal policy makers have generally disregarded the
evidence of failures. Why?
Agricultural policy has long been dominated by the influence of farm
lobbies that have generously poured money into congressional campaign coffers.
Dairy cooperatives donate almost $2 million a year to congressmen. The sugar
lobby provides $450,000, and grain lobbies provide over $500,000 a year, and
other lobbies add to the total. And of course the United States Department of
Agriculture, with a budget greater than the net income of all United States
farms, has a vested interest in maintaining the programs.
Farm policy reform has also foundered upon a public choice dilemma: farmers
have a strong interest in farm legislation while consumers and taxpayers have
only a vague interest in ending subsidies. Farm subsidies amount to only two
percent of the federal budget, yet often exceed 10OZ of net farm income for the
11
subsidized crops. A NEW YORK TIMES poll found that 55Z of the public favored
giving more government aid to farmers.
Though the farm lobbies are strong, there are still grounds to be
optimistic about reform. In 2981, legislation to perpetuate farm subsidies was
almost defeated in the House of Representatives, and the House or Senate has
repeatedly voted to abolish specific individual farm programs (though failing
to get the concurrence of the other chamber). If the GATT talks succeed and
major industrial nations agree to phase down their trade-distorting subsidies,
pressure to sharply cut farm spending will likely be overwhelming.
The Evolution of United States Policy
United States farm policy is still operating in the shadow of the Great
Depression. The farm problem in the United States began when the government
distributed hundreds of millions of acres of free farmland to former Union
soldiers and immigrants after the Civil War. This led to decades of
overproduction in the Mid-West. As early as the 1880s, activists were urging
farmers to "raise more hell and less corn." In the late 1880s, largely at the
behest of farmers, the federal government imposed price controls on railroads.
(These price controls, which continued until the early 1980s, are now widely
perceived as the primary cause for the decline of the American railroad
industry). In the 1890s, farmers led a drive for 'cheap silver'--for a
government monetary policy that would have meant the minting of unlimited numbers
of silver dollars. Farmers assumed that this would create a general price
inflation, which would make it far easier for them to pay off the mortgages on
their farms in depreciated dollars. Even before the United States entered World
12
War I, the government had established a special credit bank to provide subsidized
loans to farmers.
Once the United States entered World War I, the government encouraged
farmers to vastly increase their plantings. The government guaranteed farmers
an extremely lucrative price for their harvest, and Congress perpetuated the high
price guarantee until long after the war had ended. The government's price
guarantee meant that major crop prices in the United States were more than double
world market prices. Once the price guarantee expired, farm prices in the United
States collapsed, and land values--which had risen four fold since 1910--
declined sharply. The falling land prices boosted the bankruptcy rate, which
created a public perception that farmers as a group were suffering hard times.
Politicians focused on the post-war adjustment difficulties of agriculture to
argue that agriculture was inherently unstable and needed perpetual government
control. The farm lobby was convinced that farmers were being unfairly treated
by society because farm prices were lower in the 1920s than they had been during
the boom years of the previous decade.
A few months before the stock market crash of October 1929, President
Hoover launched the Federal Farm Board, a new agency with a $500 million budget
and a goal of driving up U.S. wheat and cotton prices. The Board succeeded in
temporarily driving U.S. prices above world prices; as a result, American exports
plummeted. Large surpluses quickly accumulated, which completely swamped
markets. The net result was the de facto takeover of the agriculture sector by
the Roosevelt Administration in 193j.
Though the condition of American agriculture has changed radically in the
last 60 years, the United States has retained the basic farm policy tools and
incentives that it developed in the Great Depression. The Roosevelt
13
Administration favored an autarkic farm policy and pressured farmers to plant
only as many crops as could be consumed in the United States. To achieve this
goal, the government rewarded farmers for leaving much of their land unplanted.
At the same time that government pressured farmers to leave land idle, it
rewarded them for boosting production on their remaining land. The Roosevelt
Administration believed that driving up farm prices would produce a multiplier
effect of prosperity on other parts of the economy. Instead, the higher food
prices reduced food consumption, which was especially unfortunate considering
the extremely high United States unemployment rates throughout the 1930s.
BOX 2.1 PAYMENT LIMITATIONS: DO THEY WORK?
The distribution of direct farm payments and the gains from farm programs
have long worried policy makers. With over 40 percent of the direct payments
of the United States government going to large farmers, about 35 percent to large
to middle size farms and only 25 percent going to small farms in 1984,
administrators, the press and politicians have expressed their concern whether
farm programs that are attempting to help small and medium family farms really
accomplish their objective. This is particularly the case when it is considered
that this distribution of direct payments understates the skewed distribution
of farm program benefits. Because large farmers produce more output and farm
programs support commodity prices, the benefits of farm programs are even more
unevenly distributed than these already alarming numbers suggest. This coupled
with press reports of million or even multi-million dollar payments to some
farmers has raised concerns that the support from the public may be being
undermined by this uneven distribution of benefits.
This concern goes back to the 1960s in the United States when there was
particular furor over one farming operation receiving a direct payment of $4.1
million. In 1970, after much debate a limit of $55,000 was placed on direct
payments under the wheat, feed grains, and upland cotton programs. Although this
payment limit was even lowered at times to $20,000, large payments continued to
large farm operations because of various exemptions and legal loopholes.
The first loophole came through the Findley amendment in 1981 which was
later amended for the 1985 United States Farm Bill. The Findley amendment gave
the Secretary of Agriculture the right to allow compensatory payments if the
nonrecourse loan level is lowered to make United States commodities more
competitive. Payments under this provision are not subject to any payment cap.
14
And payments under this provision were not small, absorbing 40 percent of the
direct payments in 1986.
The second loophole is through direct, but legal evasion (according to a
study by the Congressional Research Service, 87-12 ENR, January 16, 1987). Since
the payment limit applies to a person (in 1987, $50,000 per person) broadly
defined to include most legal entities--such as corporations, trusts, estates
etc., a farmer can create an additional entity through incorporation or
partnership formation so as to receive more payments totalling to a sum well
above limit. For example by adding more partners to a partnership or
establishing a trust with two or more beneficiaries, more "persons" can be
created to receive payments. While no one has firm data on the number of
evasions of this kind, it is known that the number of farms have proliferated
(Investors Daily noted that "it is common to find farms splitting like amoebas
from one to 10 or more units..." (August 28,1986)).
But the problem with the payment limitation is not that it is being evaded.
The more serious problem is its potential effects on farm productivity. Payment
limiitations places an incentive to have smaller farms--many of which may not be
as economic as larger farms. Productivity could be hindered if truly small
farmers proliferate with the consequence that United States agriculture becomes
less competitive--possibly creating more pressure for additional farm payments
or programs "to save the small (shrinking) family (multi-legal entity) farm."
In 1953, the administration of President Dwight Eisenhower sought to try
to roll back federal controls and subsidies of farmers. Congress resisted, and,
in 1954, imposed a system of mandatory controls which dictated the percent of
land upon which farmers were allowed to plant wheat, corn, rice, and cotton.
But, at the same time Congress imposed production controls, it also guaranteed
farmers extremely high prices for the crops they did produce. As a result,
surpluses piled up, and by 1960, the United States was spending over a billion
dollars a year just to store surplus commodities. Throughout this period, U.S.
support prices for major crops were far higher than world market prices. As a
result, farmers dumped their crops on the government, which in turn dumped the
crops on world markets. The United States sought to "solve" this problem by
creating an international wheat cartel through an International Wheat Agreement
where all exports would agree on market share, but this effort collapsed.
15
By the late 1960., farm policy makers realized the futility of their
efforts to hold American prices above world market prices. The federal
government began lowering price support levels to provide farmers with a strong
incentive for exports. Because government aid was largely intended to
'compensate" farmers for low nrices, the high grain prices of the early-mid 1970s
effectively greatly decreased American farmers' reliance on government support.
But, in the 1976 presidential campaign, candidates got into a bidding war
for farm votes, and government support levels were sharply raised. Though the
number of farmers had greatly decreased, farmers were still a major voting bloc
in many important states. The maintained political strength of farm commodity
groups became apparent in the late 1970s as dairy producers continued to be able
to boost support prices and, more importantly, the grain producers were able to
maintain support prices near the boom-year levels of the 1970s. The willingness
of Congress to enact these support levels and of subsequent Administrations to
accept them in 1977 and J981 stemmed largely from a widespread perception that
any commodity price declines would only be temporary and that the longer-term
trend in prices had turned positive in the 1970s (see D. G. Johnson, 1985, for
a contemporary critique of scarcity projections).
The 1980s saw a complete turnaround in the United States (and world) market
outlook from scarcity to surplus production. Change in the policy picture is
apparent in the debate on and provisions of the two principal agricultural laws
of the 1980s, the Agriculture and Food Act of 1981 and the Food Security Act of
1985. The 1981 Act established target prices and loan rates for the grains and
cotton at continuing high levels over a four-year period even though signs of
market weakness were already apparent. By 1982 government stocks had grown so
large that in 1983 the largest acreage reduction program in history was
16
introduced as a one-time supply reducing measure. A major drought helped further
to bring a short-term respite frzm surpluses. But by 1985, abetted by large U.S.
production and weakening export demand as the dollar had risen (by 40 percent
since 1980 in real terms against the G-7 countr;es), United States government-
held stocks had again accumulated to pre-1983 levels. It was by then clear that
no scarcity scenario was going to emerge to make the 1981 Act support prices
economically viable.
Consequently, the 1985 Act sharply reduced price support loans. However,
the target prices which established producer price guarantees were essentially
maintained at 1981 Act levels. The resulting large spread between target and
market prices, the difference between which was covered by 'deficiency" payments,
caused budgetary outlays in the neighborhood of $25 billion per year. This in
turn led to acreage diversion in 1986 and 1987 that rivaled the scale of the 1983
program. Thus ended the era of farm commodity scarcity, and the United States
government's hopes to phase down governmental intervention in United States
agriculture. In terms of budgetary costs, government stock levels, and acreage
idled, the Reagan years saw more massive farm programs than any preceding
President's, including the New Deal programs. Unfortunately, price support loans
were often still higher than market prices. As a result, the United States came
to rely increasingly more on direct export subsidies.
But, even though American programs sought to boost exports at almost any
cost, the profusion of regulations and conflicting interventions sometimes
frustrated the exorbitant export spending. The cotton program spent more than
$7 billion between 1986 and 1989, even though America has only 6,000 full-time
cotton growers. But, generous government cotton payments designed to encourage
farmers to sell their cotton on international markets at any price were by
17
another regulation designed to benefit cotton growers. As part of the cotton
price support program, Congress requires the Agriculture Department to offer
cotton growers eighteen-month interest-free loans to hold their crop off the
market, and the agency also pays for farmers' storage costs. The eighteen-month
loan allows the farmer to speculate with his harvest, guaranteeing that the
taxpayer will take any loss while farmers can keep any profit if market prices
rise above federal price-support levels during the eighteen-month period.
Cotton shippers and millers must pay cotton growers a bonus of six to eight
cents a pound above world market prices to persuade them to sell their cotton
before the end of the eighteen-month loan period. But this six-eight cent bonus
has made American cotton uncompetitive on world market, and put American textile
mills at a disadvantage in competition with foreign textile mills. This, in
part, contributes to unemployment in the textile industry and the need to
regulate textile imports.
American farm policy-making has not been goal-oriented: regardless of the
stated goal of a program, as long as the government transfers a significant
amount of resources to farmers, the program is considered a success. The
contradictions among farm programs - such as simultaneously paying for supply
controls and offering above-market rewards for production--have been obvious
for decades, yet Congress has refused to rationalize the system. The goals for
farm programs often seem to be only camouflage--existing solely to provide a
plausible reason f .r transfer payments to businessmen. Agricultural conservation
programs have fit this category for many years. The conservation programs are
justified as preserving the soil--but, as the General Accounting Agency has long
pointed out, 'conservation payments" routinely are used to pay for good routine
farming practices.
18
Farm subsidies have been perpetuated partly because Congress and the
Agriculture Department understate the predicted cost of farm programs. The 1981
four-year farm bill cost four times as much as Congress announced it would cost
in 1981, and the 1985 five-year farm bill has cost more than double the expected
cost. Since 1974, the average annual cost of subsidy programs for major crops
has been 75 percent higher each year than the Agriculture Department has
predicted. Before a program is begun or expanded, congressmen and bureaucrats
insist that it is a minor program with minimal costs; after the costs soar,
congressmen and politicians insist that it is too late to worry about the lost
money.
In 1987, the Reagan Administration attempted to reform the Farmers Home
Administration, which was loaning billions of dollars a year to technically
bankrupt or near-bankrupt farmers, thereby sustaining overproduction of surplus
crops. Reagan proposed to restrict government-subsidized loans to farmers who
were less creditworthy than before. (Studies have found that 25 percent of
bankrupt government-subsidized borrowers went bankrupt largely from receiving
too many subsidized .oans, which they were subsequently unable to service, the
low interest rates notwithstanding.) Yet, there was a firestorm of protest from
Congress and the Reagan Administration and any attempt to reduce lending was
successfully portrayed as an attempt to throw farmers "into the street."
United States Methods and Levels of Support
Farm policy reform has been stymied partly because of the complexity of
farm programs. Farm policy terminology is a maze of phrases like support prices,
target prices, deficiency payments, conservation reserve payments, set-asides,
etc. These phrases attempt to portray transfer programs as serving the public
19
interest. Programs that impose costs on consumers are applauded for not
burdening taxpayers; programs that hit taxpayers are championed for protecting
consumers. Farm lobbies have fought hard to avoid reforms of farm programs that
would make more clear the welfare element of farm subsidies.
Grain Policies
The most important set of programs in terms of both U.S. budgetary costs
and in international impact are those for the grains. For wheat, corn, grain
sorghum, oats, and rice (as well as the principal fiber commodity, cotton) these
programs have a common structure. The main elements are set by three policy
instruments, as follows.
1. The "loan rate", or market support price, is the price at which the
Commodity Credit Corporation (CCC) accepts grain as collateral for loans to
farmers, which the farmers need not pay back. The CCC ends up acquiring the
commodity, hence removing sufficient quantities from the market to prevent the
market price from falling much below the loan-rate level for any sustained period
such as a marketing year. Since no significant United States border distortions
exist for the mailL exported crops, supporting the United States price means
supporting price at all other locations around the world in which the domestic
market price is not insulated from world markets. This characteristic led some
economists to say during the early 1980s when CCC stocks werc growing rapidly
that the U.S. was bearing the burden of worldwide price supports by having CCC
loan rates set too high. In the 1985 farm bill, loan rates were sharply reduced
for all the major cormnodities. The effect on world price was seen most
dramatically in rice and cotton, where all effective market price support ceased
20
in 1986. Rice and cotton prices at United States border and other international
locations fell by as much as 50 percent within a few months.
2. The *target' price provides price insurance by making payments to farmers
to supplement market receipts. The payments are roughly sufficient to guarantee
producers the target price ("roughly' because the payments are based on U.S.
average prices, not on each producer's actual price). But to qualify for these
payments, farmers have to hold acreage idle. When target prices were introduced
in their present form, in 1973, they were below market prices. The .ice
legislation of 1975 established a target price above the market price, but like
the 1973 Act made payments only on long established base acreage so that payments
wou.d not create a direct production incentive (no subsidy at the margin).
(Actually, by raising the incentive for production on a fixed amount of land,
the government encourages farmers to farm more intensively--using more
fertilizers, more seeds, etc.) The Food and Agricultural Act of 1977, however,
made the fateful change of basing payments on current production, and with a
target level already above the market price for wheat, grain sorghum, and barley.
By 1982 target prices were above market prices for all the covered crops. The
target price consequently turned into a production incentive price which tended
to increase CCC stock buildup at the loan rates. When loan rates are cut, such
excess supplies depress world prices.
3. Acreage controls: Payments made to farmers for not growing crops were a
mainstay of 1950s programs (the "Soil Bank") and evolved into the 'set-aside"
and voluntary (paid) diversion programs of the 1960s. Set-asides were phased
out in the mid-1970s, but in 1977 were reinstated for wheat, in response to
accumulating CCC stocks. Set-asides require farmers to idle a fraction,
typically 10-20 percent, of an average base in order to qualify for target prices
21
and CCC loans. In 1978, paid diversion programs were reestablished. Theme are
essentially offers by the government to rent a farmer's land, which is then left
idle. As compared to set-aside, this approach is much preferable to fprmers.
The scale of acreage diversion was substantially expanded under the Acreage
Reduction Programs (ARP) of the 1980s, especially in 1983-87 when payment-in-
kind (PIK) programs used CCC stocks quite generously to achieve the dual goals
of reducing production and government-held stocks simultaneously. In 1983 and
again in 1987 and 1988 about 20 percent of the cropland base for the main
supported commodities was idled under ARPs, a larger percentage than at any time
in the Depression-era programs of the 1930s or the wSoil Bank" of the 1950s.
The world market effects of ARPs are the opposite of target prices--indeed the
two policy instruments could be said to have offsetting effects so that net world
supplies would be neither increased or decreased by the overall program. For
example, in the wheat program in 1987, the ARP idled about 27 percent of vl.eat
acreage; but because of high price incentives wheat yields were higher on the
remaining land. It is estimated that nearly half of the idle acreage effectively
came back into production through this slippage on yields. Similarly, in 1986,
the rice program required farmers to idle 35 percent of their rice acreage in
order to qualify for subsidies; it then paid farmers more than double the market
value of the harvest produced from the remaining cropland. The price effect of
higher prices induced an increase in production on non-idled acreage of between
15 to 30 percent, nearly offsetting the supply controls on rice acreage.
BOX 2.2 THE UNITED STATES ADDICTION TO SUPPLY CONTROL PROGRAMS
In 1934, Agriculture Secretary Henry Wallace declared, "The present program
for adjusting productive acreage to market requirements is admittedly but a
temporary method of dealing with an emergency." In 33 of the last 35 years the
22
U.S. Agriculture Department has tried to balance crop supply and demand by paying
American farmers not to grow on their land. Supply controls are the clearest
symbol of the contradictory, self-defeating nature of American farm policy.
Set-asides presume that the United States is the Saudi Arabia of wheat
and feedgrains--and that the U.S. can cut back its production, drive up prices,
and increase its profits. If nobody else in the world had any farmland, this
policy might make sense. But, in recent years, while the U.S. government has
forced taxpayers to reward farmers not to farm. Farmland in production in other
parts of the world has increased by over 70 million acres since 1980--largely
in response to high United States price supports and set-asides.
Paying farmers to cut back production stemmed from the Roosevelt's
Administration 1933 decision to abandon the export narket and instead regulate
farmers to provide only enough for domestic demand. Paid set-asides were part
of the 'domestic allotment" program--whereby farmers were allowed to grow on a
percentage of their property according to how much USDA planners estimated
national demand to be. Even though the United States is now attempting to
maximize experts, it has retained programs crafted with the exact opposite goal.
Much of the chaos in world agricultural markets in the 1980s is the result
of the 1981 United States four-year farm bill, which set American subsidy levels
far aLove world price levels. As a result, farmers boosted output and the United
States was soon swamped by the largest grain surpluses in history. Congress and
the Administration responded to the surpluses not by lowering the subsidies but
by creating new programs to pay farmers to reduce plantings. In 1988, the
Agriculture Department rewarded farmers for not planting on 78 million acres.
Set-asides are a political response to what various United States
Administrations have perceived as "excess capacity"--too many acres producing
a given crop. Yet, a 1988 Agriculture Department study concluded, 'Excess
capacity is a much more serious problem for the seven major (subsidized) crops
(wheat, corn, oats, barley, sorghum, cotton, and soybeans) than for the rest of
United States agriculture." Excess capacity is four times greater for the major
subsidized crops than for the unsubsidized crops.
The United States has had perennial set-asides in agriculture largely
because Congress insists on perpetually payi4ag farmers more than their crops are
worth. Government first artificially raises the price and then artificially
lowers production. The higher Congress drives up the price, the greater the need
for government controls on the amount produced. The federal government has never
imposed supply controls on the vast majority of crops grown in the U.S. because
farmers naturally responded to temporary surpluses by reducing their plantings
in the following year.
The supply control programs, by shutting down many farms, have devastated
rural economies. A 1987 Agriculture Department study estimated that the 1987
supply control program, which idled 70 million acres, reduced employment in the
U.S. by 300,000 jobs. The reduced sales to farmers also slashed farm input
(fertilizer, seeds, pesticides, etc.) by $4 billicn. (The high cost of the set-
supply control programs are illustrated in a Purdue University study that
23
estimated that each additional farmer kept on the land was costing taxpayers and
the economy up to $200,000 per year).
Every acre of government-paid set-aside land is a indictment of the failure
of federe.l planning. Permanent set-asides mean that government perpetually
attracts too much capital to agriculture, and then, instead of allowing a natural
adjustment and the capital to flow out, perpetually intervenes to keep some of
that capital idle.
While the government is paying farmers not to plant on good land, it has
spent billions creating more farmland and making existing farmland more
productive. The Bureau of Reclamation has spent over $22 billion since 1905 to
"make the desert bloom" - continually building new dams to make more farmland -
even though the new farmland costs taxpayers far more than it is wotth and the
additional harvests often glut markets and depress farm income.
Other commodities
While the farm lobby insists that farmers in general need assistance, there
is little or no consistency among federal programs for different commodities.
The tobacco program relies on a combination of acreage allotments and price
supports. In order to grow tobacco, a person must have a federal license. The
permits to grow tobacco were distributed in the 1930s, and current farmers must
either inherit, buy, or rent a license to grow tobacco. The government has
been widely ridiculed for having 'tobacco police" (Agriculture Department
employees) out measuring each farmer's fields to insure that he does not grow
a hundredth of an acre too much of tobacco. The government has pegged price
support for tobacco consistently at 50 percent to 100 percent higher than the
world market price. The costs of renting a federal license has sharply inflated
the cost of tobacco production in the United States. Production costs have also
been boosted because the tobacco allotment system has caused the fragmentation
of tobacco planting and preventing the development of economies of scale which
have benefitted other crops. Largely because of the tobacco program, American
tobacco exports have plummeted. And, at the same time that the government has
24
spent billions in recent decades subsidizing tobacco production, other branches
of the federal government are spending millions of tax dollars in anti-smoking
campaigns.
The peanut program combines a price support and a poundage allotment.
Farmers must have a license for each pound of peanuts that they sell on the
domestic market. The government has guaranteed peanut farmers a price roughly
50-75 percent higher than the world market. In order to isolate the peanut
farmers from lower world market prices, strict quotas have been imposed. The
Agriculture Department has even prohibited the export of certain types of peanut
butter from the United States to Canada, fearing that the peanut butter may be
re-imported and undercut the government's efforts to inflate peanut prices.
For the dairy price support program, the main policy instrument is CCC
purchases of butter, cheese, and powdered milk at support prices which generate
a legislated minimum price for raw milk. The large stocks of these commodities
that were generated by the mid-1980s support levels resulted in two short-term
measures to reduce output as well as automatic cuts in support prices when
projected CCC stock accumulation exceeds 5 billion pounds of milk annually. The
output reducing measures were: (1) contracted reductions in output of 5 to 20
percent per participating farmer in 1985-86, with payments of $335 million in
FY 1985 and $630 million in FY 1986; (2) a contracted buyout of dairy herds in
1986-87, with payments of $489 million in FY 1986, $587 million in FY 1987, and
$296 million in FY 1988. Surplus stocks were also disposed of using domestic
free distribution of cheese and butter to low-income and elderly people.
(Unfortunately, free distribution of butter led to an almost pound-for-pound
decrease in commercial sales of margarine, which hurt soybean farmers, as soy
oil is a primary ingredient of margarine). Though the distribution program was
25
officially named the Temporary Emergency Food Assistance Program, the program
has effectively become permanent. When CCC stocks were used up in 1989, Congress
added legislation for the CCC to buy more cheese in order to continue the
program.
The sugar program combines a price support and an import quota. The
quantity of imports is regulated so as to achieve a legislated price for U.S.
raw sugar. As the demand for sugar has decreased because of the development and
popularization of sugar substitutes (both noncaloric, like aspartame, and
caloric, like high fructose corn syrup) it has been necessary to cut back the
import level regularly. United States sugar imports have declined from 5 million
tons in 1975 to about 1 million tons annually in 1988 and 1989. But the U.S.
raw price has been maintained at about 18 cents per pound. The costs are borne
by sugar consumers, (and poor producers in developing countries) and are in the
billions of dollars. The exact cost depends on the price that consumers would
pay without the program, which is the world price of sugar. This price has
varied between 3 cents and 13 cents per poucd in 1986-89, so the consumer's cost
can be made to vary by a factor of 3, between 15 cents and 5 cents per pound,
depending on what world price is used. Moreover, United States policy itself
significantly affects the world price (see Millmoe, 1989).
BOX 2.3: ONE HUNDRED AND SEVENTY YEARS OF SUGAR SUBSIDIES
The United States government has been heavily protecting or directly
subsidizing the sugar industry since 1816. For almost the entire history of the
United States, American sugar prices have been held at double, triple, or
quadruple world sugar prices.
Since 1980, the sugar program has cost consumers and taxpayers roughly two
million dollars for each American sugar grower. There are only 11,000 sugar beet
and sugar cane farmers in the United States, and production is extremely
concentrated. A USDA study estimated that one corporation was receiving over
26
$100 million in benefits irom the program, and several others were receiving over
$50 million each.
Congressmen defend the sugar program as protecting Americans against
sharply fluctuating international sugar prices. The sugar program, like other
American farm programs, provides a price FLOOR but no price CEILING. Thus, USDA
prevents prices from falling but allows prices to rise as high as the moon:
price supports are always a "heads, farmers win; tails, taxpayers and consumers
lose" proposition.
The sugar program is a great inflationary success: sugar sold for 22 cents
a pound in the United States when the world sugar price was only four and a half
cents a pound. (World sugar prices are now about thirteen cents a pound). Each
1 cent increase in the price of sugar adds between $250 and $300 million to
consumers' food bills. A May, 1988 Commerce Department study estimated that the
sugar program was costing American consumers more than $3 billion a year. This
works out to over $60 a year for the average United States family of four.
Like most farm programs, the sugar programs costs consumers and taxpayers
far more than it benefits farmers. The Agriculture Department estimates that
total sugar producer income was only about $300 million. Thus, sugar
protectionism costs consumers $10 to provide $1 in income to sugar growers.
A few thousand sugar growers have become the tail that wags the dog of
American foreign policy. Early in 1982, Reagan announced the Caribbean Basin
Initiative to provide United States aid to Latin America. But, a few weeks
later, the USDA slashed the amount of sugar Latin American could sell to the
United States in order to protect the high price received by American growers.
Sugar was Latin America's third-largest export in the early 1980s, and sugar
revenues have evaporated. The State Department estimated that the reductions
in sugar import quotas costs the developing country allies $800 million a year.
By reducing Latin America's dollar revenue from sugar sales, the sugar program
has also hurt commercial banks awaiting repayment of loans from sugar exporting
governments.
High prices have lead to nosediving sugar consumption. The average
American consumes one-third less sugar now than he did in 1971. Lower priced
corn syrup and low-calorie substitutes are rapidly driving sugar out of the
sweetener market. Coke and Pepsi no longer use sugar in the-'r soft drinks in
the U.S. The government can drive up the price, but it cen't force people to
use sugar.
Congress' generosity to sugar producers is victimizing other American
farmers as well as American industries. Brazil retaliated against the United
States for cutting its sugar quota by reducing its purchases of American grain.
In the Dominican Republic, former sugar growers are now producing wheat and corn,
thereby providing more competition for American farmers. American candy
producers are losing market share to foreign competition-partly because foreign
companies can buy their sugar at much lower prices. Since 1982, dextrose and
confectionery coating imports have risen teafold and chocolate imports are up
fivefold.
27
Sugar protectionism is disrupting American commerce. In the early 1980s,
when United States sugar prices were seven times higher than world prices,
"entrepreneurs were importing high-sugar content products, such as iced-tea mix,
and then sifting their sugar content from them selling the sugar at the high
domestic price," according to the 1986 Economic Report of the President. In
order to protect the domestic sugar program, the Reagan Administration in 1985
banned imports of all products containing any sugar - thereby nullifying hundreds
of private contracts.
The sugar program has destroyed far more jobs than it has saved. American
had an efficient sugar refining industry with an excellent location near the
Caribbean. But, thanks to the forced reductions of in imported sugar, since 1981
ten sugar refineries have closed down and thousands of non-farm jobs have been
lost.
The sugar program, like most farm commodity programs, has done nothing to
encourage farmers to adjust to market realities. High federal support prices
have led to a boom in domestic sugar production--up 23 percent since 1982. Yet,
most American sugar producers remain hopelessly uncompetitive with Caribbean,
Filipino, and Australian and New Zealand sugar farmers. This is a classic case
of government generosity encouraging wasteful behavior in the private sector.
Marketing orders are another important farm program. For raisins,
California-Arizona lemons and oranges, almonds, filberts, and spearmint oil,
the Agriculture Department dictates the percentage of each farmer's harvest he
will be allowed to sell. The Agriculture Department justifies these controls
by claiming that they maximize returns to farmers. The programs were begun in
the 1930s and 1940s, and were designed to help farmers overcome the effects of
temporary gluts. But, the programs became institutionalized, and are now
administered with the goal of keeping prices permanently higher than they would
be without intervention. As a result, each year millions of pounds of fresh
oranges and lemons and almonds are fed to cattle, rather than being sold to
humans. Many regulated farmers have been driven into bankruptcy, largely
because they could not sell all of their harvest.
Other programs, for example, the Wool Act and the Meat Import Act, are
quite different in structure and complicate the picture considerably. Moreover,
28
of the roughly 400 different farm products produced in the United States, fewer
than 20 are subsidized or directly controlled by the federal government. Whether
a crop is subsidized or not depends largely on political accidents, or the clout
of various farm lobbies at the time of the 1930s.
Costs and Consequences of U.S. Policies, 1984-89
The consequences of policies can be approximated by comparing internal
prices with world trading (border) prices, but this is not a good measure for
the United States because it is large enough to influence world prices and
because the production control programs involve social costs that price
comparisons cannot capture. Preliminary results are available for a series of
studies by the U.S. Department of Agriculture's Economic Research Service that
estimate the supply-demand situation that would have existed in 1984-89 in the
absence of CCC purchases, acreage diversion, and deficiency payments. For
details, see Lin and Gardner (1989).
Table 1 shows estimated output effects of the United States unilaterally
removing its target price, loan rate, acreage control programs and sugar quota
under 1987 conditions. For the grains, soybeans, cotton, and tobacco output is
greater with no programs. The main reason is that acreage controls in 1987
outweighed the incentives for increased production caused by target-price
protection. Milk, sugar, and peanut output is less with no program. For these
commodities the production incentives of support prices dominate. Meat animal
production is largely unaffected. An overall index of output, constructed by
weighing each commodity's production by its share of the value of the total, is
3.7 percent higher in the no-program scenario. This implies that on an overall
basis U.S. policy is world-price increasing, not decreasing as is sometimes
asserted.
29
TABLE 1: Effects of eliminating farm commodity programs on production:
1987
Production 1 Change due
Production with no to ending
Commodity Unit with program program programm
Wheat mil. bu. 2,108 2,570 +21.9
Corn do. 7,064 7,350 +4.0
Soybeans do. 2,008 2,087 +3.9
Cotton mil. bale 14.8 16.1 +8.8
Rice mil. cwt. 129.6 155.0 +19.6
Tobacco bil. lbs. 1.2 2.02 +68.3
Sugar 1,000 tons 7,185 6,573 -9.5
Peanuts mil. lbs. 3,619 2,618 -27.7
Potatoes mil. cwt. 385.5 389.5 +1.0
Dairy bil. lbs. 140.3 134.2 -4.5
Beef do. 23.4 23.4 0.0
Pork do. 15.6 15.7 +0.6
Broilers do. 16.1 16.0 -0.6
Source: Gardner, 1989.
With respect to prices the commodity programs increase producer prices
for all commodities, and generally increase prices paid by consumers, also.
However, in 1986-87 consumer prices for the grains were reduced as loan rates
were cut and CCC stocks disbursed. Because the lower prices in 1986-87 were only
30
made possible by stock accumulation before 1986, it is misleading to look at 1987
effects in isolation. Table 2 shows estimates of gains and losses for different
interest groups using 1985-87 averages. Overall, according to these estimates,
producers gain $12.8 billion annually at the cost of $17.8 billion to domestic
consumers and taxpayers. Other estimates of consumer losses range to $23.6
billion per year (OECD).
BOX 2.4: THE WEALTH OF AMERICAN FARMERS
Federal farm policy is founded upon two delusions: that farmers are
comparatively needy, and that the number of farmers is decreasing. In reality,
the average full-time farmer is a millionaire and the number of full-time
farmers has significantly increased since 1980. The vast majority of the "farm
crisis" stems simply from counting part-time farmers as full-time farmers.
Farm policy in the United States has been driven by a widespread impression
that America has lost hundreds of thousands of farmers in the 1980s--thereby
supposedly proving the need for more aid to agriculture. Agriculture
Department statistics reveal that the total number of farmers went from
2,440,000 in 1980 to 2,197,000 in 1988 - an apparent decrease of 243,000
farmers.
But, this decrease is a statistical illusion--caused by the government's
antiquated, irrelevant definition of farmer. According to USDA, anyone who
sells more than $1000 in agricultural commodities is a farmer. But, Agriculture
Department statistics imply that anyone who sells one horse for over $1000 or
250 bushels of wheat a year is a bona fide farmer.
According to the official USDA statistics, most of the 1980s decrease in
the number of farmers occurred in the farmers selling less than $10,000 a year.
These are gentlemen farmers, hobby farmers, and tax farmers. The vast majority
of so-called farmers receive the vast majority of their income from off-farm
work. In the 1987 Census of Agriculture, most farmers in this classification
denied that their primary occupation was farming.
Many agricultural economists agree that the viable size of a farm now is
gross sales of over $100,000. In 1980, there were 271,000 farmers with sales
above $100,000; by 1988, there were 323,000 farmers in this class--an increase
of almost twenty percent. These farmers perennially collect between eighty and
ninety percent of all farm income.
Some farm aid advocates count farmers in the $40,000-99,999 sales class as
full-time farmers. But, as Emanuel Melichar, former chief agricultural economi3t
for the Federal Reserve, observed in 1984, "on many of these farms, the operators
either are underemployed during much of the year or have a relatively inefficient
31
operation. H.O. Carter of the University of California at Davis observed, 'As
a group, these smaller farmers are declining in numbers because they are not
large enough to compete with their larger, more efficient neighbors." According
to USDA's yield and labor estimates, a person can raise $40,000 worth of corn
in only seven weeks.
The Agriculture Department reported that, for 1988, the average farm family
had an income of $21,350. Yet, this number was calculated by simply by dividing
the total number of full - and part-time farmers with total farm income. In
reality, the average full-time farmer in 1988 reaped an income of $168,000. (The
same year, the average United States family income was $38,740). Even the class
of $40,000-99,999 farmers had an income much higher than the national average:
$39,931 (most of this came from off-farm earnings).
The financial gap between farmers and non-farmers becomes even more stark
when considering net worth. The Census Bureau concluded in 1986 that the average
net worth of American households was $78,734. (About half of American households
were worth less than $32,677). In contrast, the average full time farmer is a
millionaire, with a net worth of $1,016,000 as of December 31, 1988. (This net
worth figure is after subtracting debts). The average full-time farmer has a
net worth almost 13 times greater than that of the average American family, and
a net worth over 30 times greater than half the families of America. Even
farmers in the part-time, $40,000-99,999 sales class have a net worth of $426,487
- over five times greater than the average American family.
The concentration of wealth among a few hundred thousand farmers is leading
to a concentration of land ownership. Former USDA Assistant Secretary Don
Paarlberg notes, 'We are drifting toward a structure of agriculture which
approaches.. a wealthy hereditary landowning class, with new entrants almost
ruled out unless they are well-to-do.' The National Agricultural Forum reported
in 1984 that 'eight percent of the households in America own the vast majority
of the land... 63 percent of United States households own no land."
The magnitude of the increase in domestic prices from the farm program can
be estimated by the tariff equivalents of current quotas. A United States
International Trade Commission study (1990) concluded that, for 1986, the sugar
quota was the equivalent of a 233 percent tariff on sugar, the butter quota was
the equivalent of a 190 percent tariff, the cheddar cheese quota was equivalent
to a 132 percent tariff, the 'Americen-type processed cheese' quota was
equivalent to a 172 percent tariff, the quota on nonfat dry milk had the same
effect as a 142 percent tariff, and the peanut quota was equivalent to a tariff
32
of up to 90 percent on peanut imports. If some politician openly proposed
imposing such high tariffs (taxes) on major food items, he would be barraged by
criticism in the nation's media. But, because few Americans understand how farm
policy operates, extremely high levels of protection and subsidy have continued
unchallenged for d zades.
Many farm products that are not directly subsidized or supported by quotas
are protected by high tariffs. The tariff on orange juice is 40 percent; though
Canada has no orange groves, orange juice is much cheaper in Ontario than in New
England. Yogurt and ice cream are hit with 20 percent tariffs, while frozen
chicken carries a 28.6 percent tariff. Fresh cabbage, asparagus and broccoli
must pay a 25 percent tariff, carrots are hit with 17.5 percent tariff, and
cantaloupes pay a 35 percent tariff.
The losses to people outside the United States due to United States farm
programs are estimated to be $1.0 billion. This loss occurs because the
commodities considered, except for sugar, are net exports of the United States.
Therefore, when United States farm programs increase commodity prices in world
markets, foreign sellers gain but foreign buyers lose more.
The difference between the $12.8 billion producer gain and $18.8 cost
(including foreign losses) caused by the United States farm programs is a $6
billion worldwide deadweight loss of these programs. This loss measures the real
income given up in order to undertake United States agricultural protection.
Apart from uncertainties in elasticities and other parameters necessary to make
these estimates, several reasons have been put forth why the $6 billion dollar
figure is incomplete or misleading.
First, the administrative costs of the programs are omitted. It is
difficult to separate out the United States Department of Agriculture and other
33
agencies' budgets that constitute these costs, but they include at least the
payroll of the Agricultural Stabilization and Conservation Service, vhich is
about $0.5 billion annually.
TABLE 2: Annual average gains and losses from farm commodity programs:
1984-87 crop years
Buyers Net
domestic
Commodity Producers Domestic Foreign Total Taxpayers effect
------------------billion dollars----------------------
Wheat 3.2 -0.4 -0.4 -0.8 -3.6 -0.7
Corn 4.2 -0.4 -0.1 -0.5 -6.7 -2.9
Soybeans 0.41 -0.48 -0.30 -0.78 -- -0.07
Cotton 1.18 -0.20 -0.08 -0.28 -1.02 -0.04
Rice 0.43 0.02 0.02 0.04 -0.76 -0.29
Tobacco 0.36a -0.21 -0.11 -0.32 -0.02 0.14
Sugar 0.61 -0.78 n.a. n.a. -- -0.17
Peanuts 0.77b -0.41 n.a. n.a. -- 0.36
Potatoes 0.12 -0.12 0 -0.12 -- -0.01
Dairy 1.44 -0.99 0 -0.99 -1.67 -1.22
All program
commodities 12.8 -4.0 -1.0 -5.0 -13.8 -5.0
Source: Gardner, 1989.
al Includes gains to quota owners of $0.45 billion and losses to producers of
$0.09 billion. Overall domestic impact is positive because reduction of
supply exploits the U.S. position as a quasi-monopolist in world markets by
raising world prices.
b/ Includes gains to producers of $0.34 billion and gains to quota owners of
$0.43 billion.
34
Second, farmers expend some effort trying to comply at minimal cost with
program provisions or to make themselves eligible for payments. For decades, it
has been a common complaint that farmers have become primarily concerned with
'farming the government.' For example, some intricate contracting arrangements
have been undertaken so that farmers can obtain two, three, or even ten times
the 1985 Act's ostensible limitation of $50,000 per farm in deficiency payments.
The costs of this maneuvering are part of the deadweight losses from current
programs. However, no quantification of them is available. Third, an
agricultural information and influence industry has ariser centered in
Washington, D.C., in which each commodity group has to hire lobbyists and expend
its own time in obtaining the best political results possible for itself. Many
millions of dollars are spent in this way, but again the data for even a rough
estimate are not available.
Fourth, there are long-run resource allocation effects of programs which
may be important sources of economic mischief. Price supports, especially when
combined with disaster programs that constitute free output insurance and credit
programs which approximate free insurance against bankruptcy, provide a safety
net sufficient to prevent people who aren't managerially or temperamentally
suited to farming from moving to an occupation that fits them better. In the
long term this is no favor either to the particular farmers in trouble or to the
health of the farm sector.
Farm programs have done many things to reduce farmers' efficiency. One
recent study estimated that the requirement that farmers idle 25 percent of their
farm adds 30-40 cents a bushel to the cost of production of corn. (Some of the
most efficient farmers can produce corn for about $1.25 a bushel). The stringent
rules required to qualify for subsidies also often effectively prohibit a farmer
35
from rotating his crops. This can add another 30 to 40 cents a bushel to the
cost of production, and also results in farmers using much more pesticide and
fertilizer to compensate for the adverse effects of monoculture. Farm programs
also drive up the price of farmland, thereby increasing farmers' debt load and
increasing their vulnerability to rising interest rates. In order to qualify
for federal subsidies, an acre of land must have a history of being planted to
subsidized crops for at least three years. Two acres of practically identical
land can differ in value by 30 percent or 40 percent depending on whether crops
planted on the land are currently eligible for federal subsidy. (Unfortunately,
a prevailing reaction to the government-induced rise in farmland value has been
an increase in demand for government subsidized credit to buy farmland, thus
leading to a spiral of higher land values and higher government spending).
Finally, government spending on farm programs increases the budget defict,
raising real interest rates on farmers's loans. This not only increases the
costs of production though making borrowing for seeds and fertilizer more costly
but makes it more difficult for efficient farmers to acquire more land or others
to purchase land to start a farm.
These are examples of the unintended consequences of dozens of conflicting
government programs designed to benefit farmers. Presumably no one in Congress
or in the Agriculture Department desires to inflate farmers' cost of production;
yet, the programs have numerous effects that sharply reduce American farmers'
competitiveness. And, because changing program rules to eliminate the adverse
effects would reduce some farmers' subsidies, there seems to be a political
paralysis on fixing the problem.
More generally, the programs encourage undue risk-taking in less productive
ventures and discourage management approaches that would make farmers and the
36
farm sector more resilient and competitive in world commodity markets. These
losses are also not quantifiable but may well be the most important of all.
BOX 2.5: AMERICAN'S DAIRY QUAGMIRE
Since 1980, federal dairy policy has cost the average American family
enough to buy its own dairy cow. Annual subsidies for each dairy cow in the U.S.
exceed the per capita income of half the population of the world. While
productivity in the American dairy industry is soaring, the United States
Congress is preventing consumers from benefiting from lower dairy prices.
The United States has been awash with surplus dai., products since 1979:
The government bought the equivalent of almost nine billion pounds of milk in
1988, and expects to buy over 8 billion pounds this year. The federal dairy
price support program obliges the government to buy unlimited amounts of milk
at a set price. The federal program sets a price flow in the marketplace,
thereby guaranteeing that dairy prices will not fall below the level that
Congress decrees.
Congress has twice sought to solve the dairy surplus problem by paying
farmers to cut back production, yet each time Congress maintained price support
levels far above market-clearing levels. In 1983-84, Congress paid farmers
almost a billion dollars to reduce their production; no lasting decrease in
production occurred. In 1986-87, Congress paid dairymen over $1.3 billion to
slaughter over a million cows. A hundred and forty-four dairy owners got over
a million dollars a piece to take a five-year vacation from dairying. Yet, as
the General Accounting Office noted, 'Total milk production did not decrease
because nonparticipating farmers increased their production during the program
period."
Retail milk prices are sharply inflated by byzantine regulations that have
prohibited free trade in milk among the different states of the United States.
The federal government has over 1000 pages of restrictive rules on how milk is
allowed to be sold and employs over 600 federal employees simply to administer
the programs. The regulations were begun in the 1930s, when roads and
refrigerated technology were comparatively backward, and have been retained half
a centucy despite vast increases in technology and transportation that should
have made su:h autarchic policies a laughingstock. The Agriculture Departnient
even prohibits businesses from drying out milk in one area, shipping it to
another area, and reconstituting it as fresh milk.
Dairy is one of the United States's most protected industries, with strict
quotas limiting dairy imports to roughly 2 percent of domestic consumption. For
most of the 1980s, American cheese prices were double world market prices and
nonfat dry milk and butter prices were three times the world price. The dairy
lobby is a leading opponent to GATT reform.
37
Many American dairymen are hopelessly uncompetitive by international
standards: Australian and New Zealand farmers can produce milk for less than half
the cost of the average American farmer. But, the dairy program, by encouraging
dairy production in the areas of the United States with tne highest cost of
production, has made American dairymen appear much less competitive than they
may actually be. The dairy lcbby is extremely strong in the United States and
is one of the most vocal opponents to GATT agricultural reform.
The array of handouts and protection have not prevented a decline in the
number of American dairy producers from 600,000 in 1950 to about 130,000 today.
The Congressional Office of Technology Assessment estimates that milk output per
cow could double and that 5000 large dairy farms could supply the nation's milk
needs by the year 2000.
The cost of dairy production in the U.S. fell 4 percent in 1987 alone,
and milk output per cow jumped 3 percent in 1988. Computerized feeding methods
can boost milk yields another 5 percent without increasing a herd's total feed
requirement. Artificial insemination, embryo transfers, and cloning are helping
to boost average dairy cow productivity by a steady two-three-four percent a
year. And dairy production could explode in the next few years after the Food
and Drug Administration approves bovine growth hormones (BGH) that can boost milk
output by up to 30 percent per cow.
Several state legislature have already proposed prohibiting BGH. Instead
of seeing a lower cost of productivity and the resulting lower prices as large
benefits to low-income citizens who cannot afford sufficient calcium and protein,
politicians at both the state and federal level are rushing to attempt to ban
the new hormone. This is indicative of how perpetual protection encourages a
hostility to innovation in the protected industry.
The dairy program has cost con.umers and taxpayers far more than it has
benefited dairymen. In 1985 the dairy program cost taxpayers and consumers
roughly $8 billion while dairy profits amounted to $3.6 billion. In 1986, dairy
profits were $5 billion; subsidies cost the public around $8 billion. Thus,
consumers and taxpayers had to pay over $1.50 for each dollar of income realized
by dairymen.
Nutrition surveys have found that calcium is the most deficient nutrient
among low-income Americans' diets; a major reason for the calcium shortages is
the relatively high cost of milk. A6riculture Department surveys show that the
average American dairymen is worth over half a million dollars. Yet, despite
the disparity between low-income consumers and relatively wealthy farmers, United
State?s public policy continues sacrificing poor consumers to rich farmers.
38
II. THE EUROPEAN COMMUNITY'S COMMON AGRICULTURAL POLICY
The European Community's Common Agricultural Policy or CAP shares many of
the characceristics of United States farm policy: high costs, inefficiencies,
and trade distortions. But it also has its unique characteristics and evolution.
Nevertheless, it is trapped in many of the same political rigidities as United
States farm policy.
The Evolution of EC Policy
The Common Agricultural Policy was an essential component of the political
process which formed the European Community. At the time the European Community
was being founded, most Europeans still had stazk memories of hunger or food
rationing during World War II and the difficult post-war years. The CAP was
bound to be somewhat protectionist, for every member state protected agriculture
to one degree or another, but right from the start it was prone to excess. The
French government desperately wanted an outlet for French cereal production while
the German government felt it necessary to defend the incomes of its own farmers.
The compromise was to adopt high German prices and to ensure French sales in
Germany. Once cereals were protected other sectors had to be similarly treated
for the sake of equity, and the result was increased protection across nearly
all parts of agriculture.
There was sharp debate about the direction CAP would take in the early
years. A 1958 resolution of EC members declared that the CAP "should render
possible the application of a price policy which will avoid overproduction while
enabling goods to remain or to become competitive."
39
At first the EC was slightly embarrassed by the degree of agricultural
protectionism, and during the Kennedy Round--the Round of GATT talks started in
1963 primarily to address United States fears that the creation of the EC would
curtail their European sales--the EC offered to bind the degree of support--the
"mouton de soutien". The United States refused this offer, believing that the
bound levels of protection were too high, but the CAP has never been negotiable
since. Even now in the Uruguay Round the EC continues to argue that the CAP is
non-negotiable, and has become increasingly protectionist.
The CAP - Methods and Levels of Support
The basic instrument of agricultural protection in the EC is the variable
import levy. Roughly speaking the variable levy defines an internal price for
each product and then taxes imports by whatever amount is necessary to ensure
that they cannot undercut it. The variable levy is calculated daily from the
lowest price of imports to the Community that day. It is obvious that the
administration of variable levies is a significant and expensive task (in fact,
they are considerably more complex than described above), so they are used only
for the major items. For less important products, or where defining import
prices would be excessively complex--perhaps because a wide range of qualities
was available (e.g. processed foods) or because of significant geographic price
dispersion (e.g. fresh fruit)--the EC uses import tariffs and minimum prices to
restrict imports. There are also import quotas or "voluntary" export restraints
on certain products - e.g. beef and cassava respectively. Finally, virtually
all imports of agricultural products are subject to license. Although these
licenses must be granted freely and quickly, they are indicative of the extremely
close watch that the European Commission keeps on agricultural trade.
40
The import restrictions detailed above are supplemented by two further
groups of policies. For most commodities, including all the major ones, the EC
stands ready, through the various national authorities, to buy local product at
pre-announced prices. These prices, of course, are intimately related to those
defining the variable levies, and the buying in ensures that European production
cannot drive prices below the prescribed levels. These "intervention prices"
are the basic levers of the agricultural policy, and are subject to considerable
political debate during the annual price fixing round. As noted above, common
financing results in every member pressing for high prices for its major
products; even Britain, the staunchest critic of the CAP, fights its corner
vigorously and has usually been persuaded to agree to general price rises
provided its own products are supported and that its share of the budgetary
burden is mitigated.
Intervention buying is also the origin of the famous EC mountains and
lakes of agricultural produce. Once bought in the EC must hold--or strictly,
pay others to hold--the goods until they are sold. At the high prices defined
by the policy it is often not possible to sell the full crop to consumers, so
the excess is kept until it is exported, Jenatured or destroyed.
Export subsidies--export restitutions in Euro-speak--are the second
supplementary policy. When the CAP was initiated. the EC was either self-
sufficient in, or a net importer of, most agricultural products. Thus market
prices could be controlled by import policy and, incidentally, net revenue earned
for the Community's coffers. (Agricultural levies accrue to Brussels, not the
individual states.) Intervention prices were set so high, however, that
production grew and eventually outstripped demand. For example, self-sufficiency
(the ratio of output to consumption) rose between 1960-64 and 1985 for cereals
41
from 84 percent to 127 percent; butter from 99 percent to 113 percent; wine from
94 percent to 112 percent; beef from 97 percent to 108 percent.
The excesses above 100 percent have either to be destroyed, made unfit
for human consumption, or sold abroad. The last can only be done at world
prices, and the difference between world prices and what farmers receive (and
hence spend on production) must be met by subsidies. The result is that as
output grows it becomes increasingly expensive to maintain internal prices at
high levels, for increasing amounts of output have to be subsidized for dumping
abroad. The subsidies also increase as world prices fall, so the more the EC
dumps the more expensive each unit of dumping becomes.
Aided by these generous export subsidies, as well as by the general support
for agricultural output, the EC has greatly increased its shares of world
markets. For example, between 1970-71 and 1982-83 it increased its market share
from 8.1 percent to 17.1 percent in wheat; 22.9 percent to 50.3 percent in non-
fat dairy products, and 2.9 to 13.9 percent (1981-82) in beef and veal.
Overall, the EC pattern of trade has reversed dramatically since the outset
of the CAP. The share of agricultural imports in total EC imports has fallen
by a third and the EC share of OECD agricultural imports has fallen by 10
percent; on the other hand, policy has maintained the share of agriculture in
total EC exports and significantly increased the EC share of OECD agricultural
exports. Most OECD countries have increased their support for agriculture over
this period, so relative to world trade, the changes in EC trade have been even
more marked. For example, the EC share of the value of world agricultural and
food imports fell from 45 percent in 1967 to 41 percent in 1986, while her share
of exports rose from 22Z to 38Z (GATT, 1988). As the EC worries about its
competitiveness in high technology products it is paradoxical that the principal
42
effect of its principal policy is to promote net exports of the oldest sector
of all. Agricultural subsidies divert resources, including highly skilled
scientists, into agriculture as well as appreciating European exchange rates to
the detriment of hi-tech exporters.
BOX 2.6: THE OBJECTIVES OF THE CAP
The common Agricultural Policy (CAP) has several explicit objectives (OECD
1987):
to increase agricultural productivity and competitiveness, and thus
to ensure a fair standard of living for the agricultural community,
to support family farms,
to stabilize markets,
to ensure the availability of supplies, and
to ensure that supplies reach consumers at reasonable prices.
European agriculture certainly left plenty of room for improvement at the
outset of the CAP in 1987, and it is difficult to disentangle the effects of poor
policy from the effects of adverse economic circumstances. Nevertheless it is
hard to see the CAP as a success even in its own terms.
Agricultural productivity and incomes have fallen relative to those in
other sectors in almost every year: in some countries (e.g. the UK--see figure
1) real farm incomes fell absolutely, while across the EC, real value-added per
worker did not rise between 1975 and 1986 (IMF, 1988, T32). Even at the EC's
inflated prices the average EC agricultural worker produced just over half the
value of output produced by other workers in 1968' (OECD, 1987, T 5.11); and in
several EC countries he needed well above average amounts of capital to do so.
Agricultural employment and communities have declined in size significantly
during the CAP and small family farms have received much less support than the
major producers. In 1984 the largest quarter of farms received an average of
approximately 10,000 ECU each in price support while the remaining three quarters
averaged just over 1,000 each (Bureau of Agricultural Economics). The EC's
internal prices for most agricultural products have been stable, but at the
expense of greatly increasing price instability in world markets and without
material effect on the stability of agricultural families' incomes (EEC, 1986).
Food supplies have generally been kept available to EC consumers too, although
there have been occasional shortages (e.g. sugar in 1974), but domestic
availability has sometimes resulted in unavailability elsewhere, for example,
43
when food aid has been cut back. Finally, prices to consumers have certainly
not been reasonable. On any definition, a policy amounting to a 50 percent tax
on purchases of food is not reasonable.
The Domestic Costs and Consequences of the CAP
Self-sufficiency and booming expsrts are not, of themselves, necessarily
a bad thing; indeed, if they were based on genuine comparative advantage they
would be a matter of congratulation. But they are not. They have been achieved
only at the expense of huge production subsidies, whose cost, in turn, has been
borne by taxpayers and consumers. Consider the tax-payers first.
The CAP's intervention purchasing policy has obvious implications for
public expenditure. The intention of the policy is to transfer resources from
the general taxpayer to the farmer by paying the latter more for agricultural
produce than it is worth in the open market. As farmers responded over time to
the high prices they were offered and increased their production, government
receipts from import levies fell while outlays for intervention purchases
increased--the latter by over 400 percent between 1973 and 1986. As a result,
the price support element of the CAP now absorbs around 67Z of the entire EC
budget, or nearly 0.7 percent of EC GDP. This official largess is not evenly
distributed. It not only transfers income between sectors of each economy but
also between member countries, and not according to any recognizable criterion
of economic need. As Mrs. Thatcher occasionally notes, in the absence of
countervailing adjustments, the largest proportionate burden of the CAP falls
on one of the Comamunity's poorer members.
High agricultural spending raises obvious issues of equity (why are farmers
supported but not shop-keepers?), but it also raises more fundamental issues,
44
especially in the context of EC aspirations towards greater integration.
Agricultural expenditure is not easily controllable - in the short run because
it is determined by levels of output, exports and world prices, and in the long-
rui4 by the apparent ability of the farm lobbies to prevent significant price
reductions. Thus the agricultural share of 67 percent in the total EC budget
undermines any hope that the EC authorities would be able to influence the EC's
fiscal stance and greatly reduces their ability to affect the management and
development of the European economy in general. It rules out fiscal transfers
of the kind necessary to underpin the creation of a monetary union--transfers
to restore purchasing power in areas of incipient deficit--and also any transfers
that may be desirable to redress any inequities arising from the process of
completing the European internal market. It also casts serious doubt on the EC
authorities' ability to handle any seigniorage arising from the creation of a
single European Currency and Central Bank. The central authorities of the
European Community currently devote two-thirds of their budget to supporting less
than 4 percent of their overall economic activity, do so in a manifestly
inefficient and inequitable fashion, and seem politically hamstrung from
addressing that fact. Such institutions can hardly expect to have the
credibility to institute a dramatic movernent towards economic and monetary union
or to be a major force within any such urion that emerged. In short, the
agricultural leviathan threatens ultimately to undermine the EC's bold attempt
to complete its integration in 1992 and beyond.
The Commission has shown some awareness of these political difficulties,
for in the 1988 Budget--which was agreed under the pressure of deep crisis--it
persuaded the Council to slash agricultural spending - to 62 percent of the
budget by 1992. Further evidence of the inability of Community institutions to
45
grasp the agricultural nettle occurred in 1989. Favorable movements in commodity
prices and exchange rates reduced the costs of export restitutions below the
amount budgeted, but instead of saving or redirecting the money, the Agriculture
Commissioner was immediately allowed to start talking about increasing
expenditure elsewhere.
Community expenditure on agriculture is excessive; but it is more than
matched by agricultural expenditure by the member states. Even excluding social
security payments, expenditure by national authorities nearly doubled the amount
spent by the EAGGF in 1980; including social security payments to farm
communities, they more than trebled it. Some of the national expenditure is on
inspection and quality controls, but most is for structural reform, agricultural
development, market support and natural disaster relief. The last might appear
a perfectly reasonable item of expenditure, but few other sectors receive such
support and private markets would be quite capable of providing insurance of this
kind if only farmers would pay for it.
For consumers the cost of the CAP is related directly to the extent that
it raises prices. The CAP has the effects of imposing taxes on consumers and
giving the revenue to the farmers. The tax is implicit, however, and therefore
politically much more innocuous than explicit taxes. For example, in the UK
general election campaign of 1987 the Prime Minister publicly rejected EC
suggestions that the UK should impose a 4 percent value added tax on food in the
process of EC fiscal harmonization; yet no word was raised about the CAP which
imposes implicit taxes of ten times that levell
Table 3 shows the implicit tax on consumers of agricultural products--both
personal and corporate. The figures show the extent to which the whole range
of policies raises consumer prices relative to those that would apply if the same
46
quantities were consumed in the absence of policy. They measure the percentage
of actual consumer expenditure not devoted to buying the good in question but
used to support domestic agriculture. Taxes of 50 percent are quite common--
far in excess of those imposed on guods like cars and consumer durables or
services. The United States International Trace Commission estimated the tariff
equivalents of E.C. nontariff barriers and concluded that, for 1986,the tariff
equivalents were 212 percent for butter, 275 percent for cheddar cheese, 471
percent for nonfat dry milk, 188 percent for sugar, and 96 percent for wheat.
(United States International Trade Commission, 1990). In 1983 the CAP cost the
average family of four ECU 800 per year (Winters, 1989). Moreover, since poor
families spend a higher proportion of their incomes on food than richer families
the agricultural consumer tax falls disproportionately on the poor.
TABLE 3: Consumer Tax and Producer Subsidy Equivalents
1986-88, EC(12)
Consumer Tax Equivalent(a) Producer Subsidy Equivalent(a)
1986 198/(P) 1988(E) 1986 1987(P) 1988(E)
Total 52 51 42 52 51 46
Livestock 47 46 44 46 45 48
Crops 64 64 39 67 66 40
Wheat 57 60 31 63 66 36
Sugar 153 161 150 76 80 71
Milk 68 64 56 75 72 66
Beef 48 43 52 53 49 59
Source: OECD (1989)
(P) Provisional (E) Estimate
(a) as a percentage of actual expenditure on consumption on production
47
The purpose of the CAP is to transfer income to farmers, and as a first
step to assessing its effectiveness we may consider the so-called producers
subsidy equivalent--the percentage subsidy to farmers that would have the same
effect on their incomes as does actual policy. These PSEs can be as high as 75Z
(for rice) and average 40 percent over all commodities.
Increasing the prices that consumers have to pay for food and taxing
industry to subsidize farmers obviously affects income distribution within the
EC economy. It also, however, affects economic efficiency, as individuals
respond to the economic signals contained in the distorted prices. Consumers,
for example, switch their consumption away from food towards other goods: to gain
an ECU's worth of utility costs (l+t) ECU spent on food but only 1 ECU spent on
other goods, where t is the implicit tax on agriculture. Thus because they are
deceived into consuming less food and more of other goods than they would if they
could buy both food and other goods at prices reflecting their "true" cost, the
benefit that consumers obtain from their incomes is reduced. True cost in this
case is the world price, which reflects the costs of the marginal unit of food
produced by the world's most efficient producer, not the inflated costs necessary
to produce the goods in Europe. For producers the opposite case applies. In
agriculture 1 ECU's worth of inputs yields (1+s) ECU of private returns in
agriculture, where s is the subsidy, but only 1 ECU in other sectors. Resources
are therefore diverted into agriculture until returns between sectors are
equalized, which can only happen when inefficiency or increased agricultural
input prices have absorbed the subsidy into private costs. Relative to
production at undistorted prices agriculture is over-expanded in Europe and has
marginal costs in excess of the true value of its output (the world price).
48
These efficiency losses mean that of each ECU taken from consumers and
taxpayers only a fraction gets through to farmers as increased inco:;cs.l The
remainder is dissipated in economic losses due to inefficient production and
distorted consumption patterns. The cost to consumers and taxpayers of providing
an ECU to farmers is known as the transfer ratio. Estimates of EC transfer
ratios vary, but most lie between about 1.2 and 1.8; that means that between 20X
and 80 percent of the transfer received by farmers is absorbed by the process
of transfers (Winters, 1989). Agricultural policy is an inefficient way of
redistributing income. Estimates of the economic costs of the CAP suggests that
the CAP wastes (i.e., imposes costs on consumers and taxpayers in excess of
benefits to farmers) a staggering ECU 24 billion per year at 1980 prices.
In fact the benefits imputed to farmers in estimates of benefits/costs of
the CAP are no such thing. They accrue to the production sector as a whole and
are mostly dissipated in increases in land rents and input prices. Ever since
David Ricardo wrote in the early nineteenth century economists have known of this
possibility, and a good example of it occurred when the UK joined the EC. UK
accession to the EC raised her average levels of agricultural protection
significantly and was accompanied by a doubling in land prices. One might also
note how strongly the suppliers of agricultural inputs lobby for agricultural
protection, which suggests that they too understand the proposition.
The reason that farmers--still less farm workers--receive so little
benefit from agricultural support is that they are in elastic supply. If the
returns to farming increase, the number of farmers increases, or (in the E.C.)
1 Depending on how each program is administered, the losses may be
mainly to consumers (the consumer tax equivalent is much higher than
the producer subsidy equivalent for sugar), mainly to taxpayers, or
some combination.
49
does not fall as rapidly as it otherwise would. The amount of land, on the other
hand, can hardly increase at all, and since farmers need land to grow the crops
to earn the subsidies, they compete for it and drive its price up until all or
nearly all their extra earnings from higher subsidies are absorbed by higher land
costs. Thus the EC's agricultural policy combines a consumer tax--which falls
disproportionately on the poor--and a capital transfer to land-owners, who are
predominantly rich.
A further consequence of promoting agriculture above other sectors is to
reduce output, employment and net exports of other goods. General equilibrium
analyses of the CAP quantify these consequences: for example, OECD (1989b)
estimates that the CAP reduces manufacturing and services output by 2.1 percent
and net exports by about 17 percent of gross exports. Moreover, if wages are
not perfectly flexible in the EC--and they are probably not--the penalties
imposed on other sectors for the sake of agriculture show up as reduced
employment, possibly by as much as 1.5 percent of the total.
A 1988 OECD study estimated the effects of the abolition of the CAP on
the West German economy, the largest national economy of the EC. The OECD
concluded that, without CAP, agricultural output would drop by five and three-
quarters percent, agricultural employment by eleven and a half percent, and
agricultural exports by eighty-six and a half percent from the levels they would
otherwise have attained. On the other hand, lower agricultural prices reduce
nominal wages by a little more than one and a half percent. 'Owing to lower
labor costs and cheaper agricultural inputs, the competitiveness of industry and
the traded services sector improves; output and employment in these sectors
therefore increase significantly.... Reflecting higher aggregate domestic demand
and lower production costs, output and employment in the nontraded services
50
sector increase by three and a half percent and five and a half percent,
respectively. The consumer price level declines by about one and three-quarters
percent owing to lower agricultural prices. Aggregate employment increases by
five and a half percent as the other sectors provide more jobs than are lost in
agriculture. Real income and domestic demand, therefore, increase by about three
and a half percent." (IMF, p.11).
A 1988 study by the Kiel Institute of World Economics estimated that
abolishing the CAP would boost employment by 850,000 workers--roughly 4 percent.
This would have lowered Germany's unemployment rate in 1987 from about nine
percent to five percent. The Kiel study concluded, 'the policy intended to help
farmers in fact constitutes a taxation of Germany's growth and export
industries." The Kiel study also notes, 'Currently, total public subsidies to
agriculture amount to well over DM20 billion, equivalent to aboux. 70 percent of
this sector's gross value added at domestic prices." This makes it clear that
subsidies are costing German taxpayers and consumers far more than they are
benefitting German farmers, since profit percentages are far less than 70
percent. (Dick, et. al., 1988).
The Foreign Costs and Consequences of the CAP
The costs of the CAP fall primarily on the EC member states themselveL,
but some spill over onto the world economy. They do so through three principal
mechanisms: the level of world prices, the variability of world prices, and
preferential trade arrangements.
51
The CAP taxes EC consumption and subsidizes EC production so that for
nearly all products it increases the EC's net supply to world markets.2 This
depresses world prices and does so quite independently of whether the CAP
increases EC exports or reduces imports by an equivalent amount. There is no
sense in which taxing imports is less disruptive of world markets than
subsidizing exports.
Countries which really must rely on world markets for their food supplies
could in theory benefit from the price-depressing effect of the CAP, but many
do not realize these benefits. Instead, governments come under pressure to
protect domestic producers from the cheap "dumped" commodities, and often respond
by restricting imports that wou'.d have otherwise been beneficial. Other
countrips export the goods whose prices the CAP reduces and thus suffer a terms
ol trade reduction, and many of the world's current food importers would switch
to exporting and be better off for it at the prices that would rule in the
absence of the CAP.
A more critical effect of the CAP on developing countries concerns the
stability of world market prices. The CAP insulates EC producers and consumers
from external shocks and thus increases the effects of the latter on world
prices. Estimates suggest that the operation of the CAP doubles the variability
of world dairy prices, raises that of wheat and beef prices by 50 percent and
that of sugar by 25 percent (Winters, 1989). To mitigate such shocks, developing
country governments are led to intervene in their economies to a degree well in
excess of their ability to do so effectively. The result is disruption of their
2 There are exceptions arising from particular cross-commodity effects:
for example, the taxes on grains increase EC demand for grain
substitutes such as cassava.
52
economic inefficiency and a tendency to shift activity away from agriculture into
industry.
The resource shift out of agriculture induced by increased variability is
exacerbated by the change in the nature of the price variability that the CAP
induces. Under free trade prices vary, but in response to weather, natural
disaster and taste changes, all of which are random and largely reversible.
These fluctuations amount to "risk" in the technical sense. "Risk" is sometimes
insurable and is always open to the mitigation of the law of large numbers--over
a reasonable number of years it evens out. The CAP, on the other hand, produces
uncertainty--fluctuations that are inherently unpredictable even in a
probabilistic sense. The CAP's major decisions are political and long-lasting;
thus rather than studying weather patterns, developing country economic managers
must try to predict political pressures, and with the knowledge that a mistake
could cause not two years of low incomes but a decade of misery if, for example,
the EC decided to reduce its imports of a good after new processing capacity had
been introduced.
Some developing countries experience direct effects from the CAP by
basically becoming part of it. They do not necessarily gain from it, however.
The Lome Convention accords African, Caribbean and Pacific countries preferential
access to the EC market, but has hardly any impact on agricultural trade because
most temperate products are either excluded from it or are subject to extremely
small margirs of preference. The General System of Preferences extends certain
preferences to other developing countries, but not on goods subject to variable
levies (i.e. the main ones in agriculture). More direct preferences are granted
on beef, sugar, bananas and rum, for which quotas of duty-free access are granted
to particular former colonies while other suppliers are kept out. Sales of the
53
permitted imports command high prices inside the EC and offer significant
transfers of income to the lucky exporters. They also have caused a tremendous
expansion in production in these countries, in some cases at the expense of other
goals. 'he banana boom in the Caribbean has discouraged diversification in a
classic "Dutch diseaLeW syndrome, and has led producers to plant on fragile
slopes, threatening serious damage to the fisheries and tourist industries from
the consequent erosion and run-off. Moreover, these preferences also drive down
world prices because they serve either to increase the EC's surpluses (beef and
sugar) or to reduce its imports from elsewhere. This fall in the world price
is the only effect felt by most developing countries - i.e. those with only small
or zero quotas; moreover, it may outweigh the transfer effect in total if, by
buying from inefficient suppliers, the EC policy increases developing countries'
total output rather than merely redirecting it. The benefits of these quota
policies fall very unevenly and bear no relation to recipients needs for foreign
aid.
III. JAPANESE AGRICULTURE SUBSIDIES AND INTERNATIONAL TRADE
The Organization for Economic Development, in a 1987 comprehensive study
of agricultural subsidies (producer subsidy equivalent) showed that Japan has
the highest agricultural protection in the world. The price of rice in Japan
is six times the world price while the price of beef is up to ten times the world
price. Farmers are paid four or five times the world price for producing wheat
and soybeans, and four times the world price for silk.
Japan's agricultural protectionism began with the Russo-Japanese war, when
Japan imposed a 15 percent tariff on rice to help finance the war. In 1918,
54
there were major riots in Tokyo over rice shortages. In 1942, as part of the
war effort, the government sharply increased subsidies for rice production. As
with Europe, the severe hunger experienced in Japan during and after World War
II ma"' the public receptive to subsidizing farmers in order to secure adequate
food supplies. The government has committed itself to an official policy of rice
self-sufficiency.
Japan's agricultural trade barriers are legendary. Ri'e imports are
strictly prohibited: people have been arrested at Tokyo Airport for attempting
to smuggle five pounds of rice into Japan. Japan has quotas on milk, cheese,
cereal flours, starch, meat preparations, sweeteners, fruit juices, and even
tomato sauces. All food importers must be licensed and the Ministry of
Agriculture, Forestries and Fisheries is notorious for "jawboning" licensees to
limit their imports, as Bela Balassa (1987) pointed out.
Rice is the foundation of Japanese farm policies. While world rice prices
have fallen sharply in recent decades, the Japanese government has awarded
farmers higher rice prices almost every year since 1942. (Only very recently
have rice prices fallen slightly.) Since rice is the primary food item in Japan,
higher rice prices pull up the prices of other food items.
Japanese policy has sought to preserve almost all farmland in the nation.
Special tax advantages and subsidies have driven the value of rice land to over
$90,000 per hectare--over 50 times the value of good American farmland. High
farm subsidies have, by making it very difficult to buy land, contributed to a
severe housing shortage in Japan: the average Japanese citizen has less than
half as much housing space as the average American.
Japanese government policies have created perhaps the least efficient
farmers in the industrial world. It would take over 150 average Japanese farms
55
to equal the size of one average American farm. Because Japanese farms are so
small, farmers lack the economies of scale of their competitors and cost of
production for major crops is far higher in Japan than elsewhere. Comparing the
ratio of labor productivity between agriculture and overall average labor
productivity in the economy shows profoundly different results for the U.S. and
Japan. In 1955, labor productivity in United States agriculture was only 51.7
percent of the productivity of the entire economy. But, by 1980, agricultural
labor productivity was 20 percent higher than that of the general economy. In
Japan, in contrast, agricultural labor productivity was 23.3 percent of general
productivity in 1955 and fell to 18.2 percent by 1980.
Yet, despite this abysmal productivity, Japanese farmers enjoy higher
income than non-farmers, thanks to government subsidies. Only fourteen percent
of Japanese farmers are full-time: the other eighty-six percent have jobs off-
the-farm. This partly explains the low productivity, since part-time workers
lack the time or devotion to farming that full-time farmers have. The government
is determined to maintain parity of income between farmers and non farmers--and
as farmers become increasingly less efficient, the government has had to drive
up food prices higher and higher in order to provide them with a good income.
Farm subsidies impose a brutal cost on Japanese consumers. Japanese
consumers spend 32 percent of their income on food, while Americans spend only
13-14 percent of their income on food. A 1987 study by Anderson and Tyers
concluded that the per capita costs of Japanese farm policies are four times
higher than the European Community's farm subsidies. The average Japanese
citizen consumes only six kilos of beef a year. The U.S. International Trade
Commission estimated the tariff equivalents of Japanese non-tariff barriers on
farm imports as 595 percent on butter in 1986, 344 percent on nonfat dry milk,
56
542 percent on butter, and 733 percent on rice. (U.S. International Trade
Commission 1990).
In 1961, the Japanese Diet passed the Agricultural Basic Law, which
enunciated a clear goal of achieving income parity between farmers and non-
farmers. As Hillman and Rothenberg (1986) note, "Since 1975, average (Japanese]
farm household income per capita has been higher than urban household income per
capita by as much as 15 percent." As Fitchett noted in a 1988 World Bank study
noted, 'During 1984-6, average farm household incomes exceeded average blue-
collar household incomes by 30 percent". The difference between farmers and
non-farmers' financial condition is even more stark when considering net worth.
Since farmland prices are so high in Japan.--farmers' average net worth is many
times greater than the net worth of non-farmers. A recent study by economist
D. P. Vincent, of the Center for International Economics in Australia estimated
that Japanese agricultural policy results in a reduction in the average real wage
level by 2.5 percent--equivalent to about 101,000 yen per worker in 1984.
Vincent concluded, "A particularly important consequence of Japanese agricultural
protection is to reallocate significantly a diminished aggregate income away from
Japanese wage earners and towards the owners of rural land. The rental price
of rural land is raised by about 68 percent."
Most of Japan's overt protectionism is now agricultural, and is the
lightning rod for catching the world's frustrations with Japan's mercantilist
export-at-any-cost policies. While Japan insists on its right to export
unlimited amounts of products to the world, it refuses to buy other countries'
products even when foreign nations have a clear comparative advantage. Japanese
farm lobbies have worked hard to stir up hostility to and distrust of foreigners
in order to persuade the public of the need to perpetuate farm subsidies. Heavy-
57
handed (and often hypocritical) pressure from the United States for farm trade
reform has helped divide the two nations.
Japanese farm policies clearly distort world agricultural trade, but it
is unclear exactly who would be the beneficiary of Japanese trade liberalization.
U.S. cattlemen are anxious for the lifting of Japanese beef quotas--but, free
beef imports would slash Japanese farmers' purchases of American feedgrains, and
Australian and Canadian cattlemen could reap much of the increased beef sales.
When Japan was considering abandoning its quotas on citrus imports, the largest
American export company--Sunkist--publicly opposed trade liberalization because
it was concerned about being forced to face new competitors. If Japan opened
up its rice market, it is likely that Thai farmers would reap the benefits,
since they are lower-cost producers than American farmers. Hillman and
Rothenberg (1986) estimated that Japanese trade barriers were costing Thai
farmers alone $270 million per year.
It is likely that agricultural liberalization would do little to reduce
Japan's trade surplus, though the removal of such flagrant protectionism might
ease some foreign countries' hostility towards Japan.
58
CHAPTER 3
GOVERNMENT INTERVENTION IN AGRICULTURE IN DEVELOPING COUNTRIES
In many developing countries there is little recognition of the notion that
farmers' rights to the fruits of their labor are no less important than those
of consumers. In the absence of such notions of inherent economic rights, the
deck is stacked against agriculture, especially with respect to food pricing
policies and exchange rate policies, since producers (even if numerically
superior to urban interests) are poorly organized and usually lose battles with
politically volatile consumers in the cities. Policies are analyzed in terms
of whether they meet certain objectives (income distribution, self-sufficiency,
exports, etc.), rather than in terms of whether they erode or preserve the
individual's ability to make economic choices. This disregard of the concept
of economic rights was so deeply rooted that governments in some countries, (for
example, in the socialist economies of Africa) viewed almost any unconstrained
trade between individuals as likely to be against the public interest. In
Ethiopia and Tanzania, traders who attempted to buy grain in one region and sell
it in another were harassed and even thrown in jail, with the result that serious
shortages in some parts of the country co-existed with surpluses in others.
The pervasive rejection of farmers'--and for that matter, other
individuals'--inherent economic rights, led naturally to a profound distrust of
market mechanisms. Thus, nearly every perceived problem--be it inequality of
income distribution, high margins in processing or distributing agricultural
products, or low levels of food self-sufficiency--prompted a new government
59
intervention. Basic development strategies called for industrialization, usually
to be accomplished by overvaluation of exchange rates and restrictions on imports
of manufactured items.3 But this hurt farmers, reduced agricultural exports and
increased food imports. Offsetting measures became necessary, such as subsidized
fertilizer, credit, and irrigation. But these were costly and their financing
required higher taxes and increased external borrowing, further overvaluing the
exchange rate. Price controls instituted to help urban consumers reduced or
eliminated profits of farmers drove private traders out of the market; the
solution was to give legal monopolies to marketing agencies. Prices that
differed across time or regions of the country were taken to indicate
inefficient, speculative, or exploitative private trading activities; the
solutions were regulation of trade (margin controls, banning of trade by certain
ethnic groups, regulations governing the movement or storage of commodities) and,
again, parastatal monopolies. Over the years, these policies have created the
attitude that all characteristics of the economy are the responsibility of
government. The cycle is perpetuated; intervention begets pressure for more
intervention.4
In most developing countries, government interventions have profoundly
disrupted the agriculture sector by directly and indirectly taxing farmers and
subsidizing consumers. Prices received by producers and paid by consumers are
usually set by administrative decree to meet political objectives. Low
politically-decreed prices to producers and consumers have tended to sharply
In fact, these macroeconomic distortions have imposed greater costs on
the agricultural sector than has direct taxation. See Krueger, Schiff,
and Valdes (1988).
One developing region that is an exception to this stereotypical
scenario of policy development is East Asia.
60
reduce farmers' incentive for production while increasing consumption of urban
dwellers. By lowering farmers' prices while subsidizing and controlling consumer
prices, many developing country government have had to rely on imported foods,
dumped by industrial countries as a result of their farm policies. In severe
cases when foreign exchange is scarce or domestic production is unusually low,
this policy has resulted in severe food shortages. As a consequence, many
farmers have abandoned their farms to migrate to cities, many finding even more
severe poverty. Though agricultural producer prices are generally suppressed
in developing countries, the actual effects of government policies varies widely
among developing nations. But, whatever the goals of policy, the policy tools
used--especially government (parastatal) price controls enterprises, and trade
quotas--greatly increase the cost of reaching the objectives.
Governments have attempted to offset the anti-agricultural bias by
subsidies to fertilizer and credit and public investment in infrastructure
(especially irrigation). The input subsidies inevitably go primarily to large
farmers and have encouraged environmental degradation and discouraged employment
of rural labor. Governments have aided agricultural development with investments
in rural infrastructure; unfortunately, such investments have been radically
reduced in the 1980s as many nations struggle with the debt crisis. The r,et
effect on production of the combination of suppressing crop prices and
subsidizing farm inputs is generally to depress farmers' profits. And the
conflict of policies results in a large waste of resources and nations with
impoverished farmers and hungry consumers.
61
1. PARASTATAL MARKETING ORGANIZATIONS
Parastatal enterprises, usually organized as government-owned
corporations,5 afflict agricultural sectors throughout the developing world.
They operate in (and often monopolize) markets for agricultural inputs, outputs,
services and trade. While most were originally organized to perform a marketing
function, a number have evolved to the point where they control all aspects of
production, from determining which varieties must be planted (the Zimbabwe cotton
board) to distributing seeds and other inputs, to directing the harvest (the
Cyprus potato board). (See, e.g., Abbott, 1987.) They are most pervasive in
Africa and the history of their genesis there is instructive (Lele and
Christiansen, 1988). The early marketing boards were put in place by colonial
governments as convenient ways of using the coercive powers of the state to
regulate small African growers, thereby protecting large European farmers against
competition. After independence, the boards were retained and expanded by
governments who wanted to control all aspects of production and marketing, and
especially to discriminate against certain ethnic groups that were active in
trading (e.g., those of Indian extraction in East Africa6 and of Lebanese in
Senegal). New boards proliferated; in Tanzania in the mid-1970s, for example,
there were ten parastatals handling production, processing, transport and
marketing of 42 crops. These boards often displaced private traders that, when
the comparison has been studied, were more efficient. This has been documented,
5 In a few countries in Africa (e.g., Tanzania, Cameroon, Senegal),
producer cooperatives have also operated as parastatals when the
governments began to appoint managers and appreve budgets.
6 Malawi went even further, and legally forbade Asians from living in
small towns or rural areas (Lele and Meyers, 1987).
62
for example in Kenya, Indonesia, Senegal, Sri Lanka, and Tanzania (Lele and
Christiansen, 1988; World Bank, 1986; Bryceson, 1985). This explosion in the
role of parastatals was encouraged by the neutral or even supportive attitude
of the donor community. The countries that received th.e most foreign assistance
(e.g., Senegal, Tanzania) were those in which they multiplied the fastest.
While parastatals in other regions do not share the African parastatals'
colonial origin, they were all conceived as ways of exercising government control
over agricultural production and marketing decisions through pricing policy and
direct intervention. The vast majority also share a common outcome; they create
tremendous distortions in incentives, operate inefficiently, and drain national
treasuries. Table 3-1 shows how onerous is the burden of some parastatals in
the 1980s. Column (a) shows the size of government transfers to the parastatal
in relation to the size of the budget, indicating how much they reduce public
resources available for other purposes. Column (b) shows transfers plus
borrowing, in relation to national production, indicating the magnitude of the
burden on the economy as a whole. By either measure, the parastatals have
imposed very large costs. The reasons behind this outcome can be found in both
the pricing policies followed and problems in their design and management.
Prici
Prices of important agricultural products in developing countries are
almost always set in the political arena, either by the parastatals or by
legislation. The usual policy is to set prices low relative to their
63
international levels,7 and at uniform levels throughout the coun.try and
throughout the year.
It has long been recognized that agriculture in most developing nations
is heavily taxed, though the patterns of policies by which this is done have only
recently been systematically compared across countries. A study of 18
representative countries found that the domestic prices of export crops were in
almost all cases kept below international prices (converted at the official
exchange rate), by an average of 11 percent (Krueger, Schiff, Valdes, 1988).
Imported food crops were a different matter; most countries kept domestic
Table 3-1: Selected Agricultural Marketing Parrstatal Losses
Loss/Subsidy as percentage of
Country Parastatal Period (a) Govt. Cur. Exp. (b) GNP or GDP
China Grains 1988 10.5 2.0
India Grains 1984-85 4.6 0.5
Gambia Groundnuts 1982-87 10.8 (26.6) 2.8 (14.4)
Kenya Grains 1985 3.7 0.7
Malawi Crops/inputs 1983-87 2.6 (2.8) -4.3 (35.8)
Mali Grains 1982-85 8.8 (10.4) 1.3 (1.5)
Mexico Milk, Grains, Oilseeds 1982-85 3.5 (5.2)
Niger Grains 1982-85 0.3 (0.3) 0.2 (0.3)
Senegal Groundnuts 1982-86 1.5 (3.8) 0.6 (0.6)
Tanzania All crops 1980-81 12.4 1.7
Zambia Maize, Fertil., Cotton 1980-86 4.0 (11.6) 3.2 (7.2)
Zimbabwe All crops 1983-87 5.6 (6.4) 4.6 (5.3)
Sources: Swanson and Wolde-Semait, 1989 (Gambia, Malawi, Mali, Niger, Senegal,
Zambia, and Zimbabwe); Lele and Christiansen, 1988 (Kenya); World Bank, 1983
(Tanzania); World Bank, 1986, p. 89 (India); World Bank, 1989, p. 17 (Mexico);
World Bank, 1990, p. 4 and 17 (China).
ai Figure in "Loss/Subsidy" column (a) refers to median government transfer to
parastatal for years indicated. Figure in parenthesis is the highest figure
for those years. Figure in column (b) refers to median government transfer
7 In many cases, stabilization policies have caused domestic prices in
some years to exceed world prices, but the average effect over the price
cycle is to depress them.
64
plum deficit for the years indicated, as a fraction of GNP or GDP. Figure
in parenthesis is the highest figure for those years. For China, figures
represent financial losses of grain bureau enterprises, as percentage of
total government expenditure and GNP.
producer prices higher than world prices, by an average of 20-21 percent.
However, an additional 'hidden" tax was imposed on all tradable crops by
overvaluation of the exchange rate and protection of the industrial sector. The
study found this indirect mechanism to be by far the most significant way of
taxing .griculture, overwhelming even the apparent protection provided by pricing
policy for imported food crops. On average, the total effects (from pricing and
the hidden tax) were equivalent to a tax of 36-40 percent or export crops and
a tax of 5-6 percent on imports.
In other countries not included in this stu , the effect of pricing and
exchange rate policy has been even worse for agriculture. In China, grain
producers are forced to sell part of their crops at below-market prices, at a
cost to them in lost revenue in 1988 equivalent to 1.7 percent of all GNP (World
Bank, 1990). In Tanzania by 1984, official prices for export crops (almost all
of which could be legally marketed only by parastatals) had fallen in real terms
to about half their levels of 1970, in spite of higher border prices. When
adjusted for overvaluation of the currency, the official prices in 1984 were less
than 20 percent of their values in 1970. In Senegal, groundnut producers only
received about half the export value of their crops. In addition, for some years
they were paid in "bonds" that could be redeemed for cash only after considerable
delay (Caswell, 1985).
Such low-price nolicies have important unintended effects over a period of
time (World Bank, 1986). One effect that was particularly pervasive in Tanzania
was the emergence of parallel domestic markets. This tendency was exacerbated
65
by the pan-territorial pricing policies discussed below. A second is a decline
in production. Though it is believed in some circles that peasant farmers do
not respond to price incentives, this is clearly not the case. Countries in
which producer prices have been severely depressed have consistently found
production declining. In the early 1960s, Sri Lanka accounted for a third of
world tea exports, while Kenya's market share was less than 3 percent. Over the
ensuing decades, however, Sri Lanka taxed the sector quite severely; average tax
rates were over 50 percent in the 1970s and over 35 percent in the late 1970s
to mid-1980s. Kenya's taxation was much more reasonable; in 1985, rates were
on a sliding scale based on the world price, with the top average rate about 15
percent. By the early 1980s, Sri Lanka's share of the market had declined to
19 percer while Kenya's had more than tripled to 9 percent. In Argentina,
another country with a strong policy bias against expurts, it has been estimated
that a more neutral policy environment could have doubled agricultural exports
(Sturzennegger, forthcoming).
A third effect of such pricing policies is to encourage (in some cases,
virtually force) producers to smuggle their crops out of the country. Ghana's
Cocoa Marketing Buard's pricing policies, combined with overvaluation of the
exchange rate, raised the effective taxation of cocoa from an alreadv-high 54
percent in the late 1960s to 89 percent in the late 1970s. Ghana's market share
dropped from 40 percent to 18 percent. Neighboring Cote d'Ivoi.e's share rose
from 9 to 29 percent. Some of Ghana's decline and the Cote d'Ivoire's rise in
market share was due to proc.ction effects. But, since the increase in Cote
c.'Ivoire's exportable production could account for only part of its increased
exports, it is clear that a significant part of the increase in exports from Cote
d'Ivoire came from cocE ggled out of Ghana. Ghana's pricing policies not
66
only impoverished the Ghanaian producers, but also deprived the treasury of
revenue.
Other aspects of pricing policies are generally not as detrimental to
producers as depressing prices overall, but have serious consequences
nonetheless. One common policy fur food grains ("pan-seasonal pricing") is to
maintain prices the same year-round, irrespective of the proximity of the harvest
or the state of stocks. The major adverse effect of this is to discourage the
private sector from holding stocks, siace normally prices must rise from times
of abundance (immediately post-harvest) to times of scarcity (immediately pre-
harvest) in order to cover the costs of carrying stocks. As a result, there is
a chronic shortage of private storage facilities in almost all developing
countries, lea ing storage responsibility largely to the parastatals. Because
of their usual inefficiency and undercapitalization, physical storage losses
can be quite high. Estimates of losses in Tanzania run as high as 30 percent
(Bryceson, 1985). Pan-seasonal pricing also encourages consumption and
discourages production off-season, when the full cost of providing the product
(growing it plus storing it for a long period) is highest. This effect is most
serious in countries like Peru, where each of the two major regions can grow rice
in the season when the other is not producing.
Another policy commonly followed for boti exports and food crops ("pan-
territorial pricing,) is to pay producers the same price throughout the country.
Taxpayers, consumers,and producers close to consumption or shipment centers are
essentially forced to subsidize those in distant locations, where prices would
normally be lower because of the high cost of transporting the product. This
practice is usually justified as a measure tu promote development of a backward
region, but in general, infrastructure investment would be a far better way of
67
supporting such a goal. In some countries, this policy is carried to an extreme,
as in Peru, where rice producers in the inaccessible jungle region are paid a
higher price than those in the coastal region, where transport costs are lower
by about US$72 per ton. In Tanzania, costs of transporting maize ranged among
the 20 regions from 22 to 660 shillings per metric ton (US$3 to US$81 at the
official exchange rate) in 1979. The pan-territorial pricing generated losses
for the National Milling Company of several hundred shillings on each ton
transported from the remote southern region, Ruvuma; where large maize surpluses
were produced. Costs have also been shown to be quite high in Zambia, in terms
of production foregone and government subsidies (Kydd, 1989).
Pan-territorial pricing has had two very different effects in different
countries, depending partially on the relation between official and market
prices. In Tanzania, the uniform official price for crops has often been very
high relative to the market price for remote regions, but low for regions where
transport costs are low. This has caused a segmentation of the market. The
National Milling Company buys virtually all the crop in outlying areas, while
a thriving (but illegal) private sector handles the cr)p in other areas.
Official channels in 1984 handled less than one-third the average annual quantity
of rice handled in the 1970s. This is typical of many other African countries,
where in spite of regulations and rhetoric, the public sector markets only a
small part of the harvest (Hopcraft, 1987; Green, 1989). This also means that
most consumers must buy grain in the parallel market, where prices in Tanzania
have conmmonly been 4 to 5 times, and sometimes up to 10 times, the official price
(Hopcraft, 1987; World Bank, 1986). In Ethiopia, the parallel market price of
tef (a local grain) in the capital rose to over 7 times the official producer
price (Hopcraft, 1987). The grain sold at the official price must be rationed,
68
and typically goes to politically powerful urban groups or the armed forces
(Arhin, Hesp, van der Laam. 1985).
But in the other countries, the combination of low consumer prices, pan-
territorial and pan-seasonal producer prices, and/or a parastatal marketing
monopoly have driven the private sector completely out of many agricultural
markets. Or, even when the parastatal does not have a de facto monopoly, it may
have to give private processors subsidies to cover losses caused by the low,
controlled selling price, as was the case in Mexico until recently. Colombia
uses a complicated system to subsidize private storage, with effective rates of
subsidy (as a percentage of the price) varying from 5 percent to 14 percent for
different crops in 1980, and changing over time as well. Any of these policies
that force the parastatal to cover losses incurred on the entire domestic crop
(and often on imports as well) can quickly cause operating deficits to balloon
out of control, resulting in the financial and efficiency costs indicated in
table 3-1.
Management and Operation
In addition to uneconomic pricing structures over which they sometimes have
little control, parastatals the world over are beset with a plethora of
management difficulties. As one might expect of agencies whose employees handle
large sums of cash and exercise considerable control over other peoples' lives,
outright corruption is a persistent problem. Estimates of its magnitude are hard
to come by, but to give some idea of its seriousness, reports from Senegal
indicate that the government admitted fraudulent losses of the major parastatal
ONCAD of an amount equal to 44 percent of the public sector investment budget.
In addition to the direct siphoning of funds (Bryceson, 1985), leakage of
69
supplies purchased by the parastatal into the higher priced parallel market are
common (Hopcraft, 1987).
But even disregarding the out and out fraud, parastatals often fulfill
their missions inefficiently, if at all. Since they are not good forecasters
of crops (partially because they often operate without basic data) they end up
buying, accumulating stocks, and selling at the wrong times, thereby
destabilizing the very markets they were intended to stabilize (Idachaba, 1985).
(As shown in Box 3-1, in 30-35 percent of the countries and export crops studied,
actual domestic producer prices were less stable than if they had simply followed
world levels.) The segmentation of markets into official and parallel sub-
markets also magnifies the effect of supply and demand shocks in each. Sometimes
prices for the next harvest are not announced until after the crop has been
planted, exacerbating the uncertainty facing nroducers. This is standard
practice in Zimbabwe (Gael, 1988) and Tanzania, where it is justified as a
measure to discourage speculators. (Ironically, speculation is considered
detrimental precisely because of the instability and uncertainty it allegedly
createsl) In other countries (including the United States), late announcement
of prices is an unintentional but inherent result of setting prices through a
time-consuming political process.
But above all, parastatal marketers operate inefficiently because they
operate inflexibly. They cannot adapt readily to changing market circumstances.
In Zimbabwe, Kenya, and Malawi in 1986, for example, official prices were kept
constant in spite of massive oversupply and severe budgetary losses that should
have lowered the price (Hopcraft, 1987). Conversely, in other countries,
official prices have been maintained at low levels even in times of major
shortages (Ethiopia). Private marketers have been shown to stabilize producer
70
prices by adjusting margins pro-cyclically.8 Parastatals simply cannot respond
flexibly like this, because it is usually politically impossible for them to
quickly shed labor and take other cost-cutting measures in a timely manner.
Bureaucratic inertia delays decisions, so that a response to a given market
condition may be completely inappropriate to the conditions at the time the
response is finally made.
Reforms
While great emphasis is sometimes placed on reforming parastatals, it
should be noted that many if not most of the problems enumerated here are
intrinsic to an organization structured as a parastatal. Parastatals are by
definition public institutions and therefore political. Their goals are
politically determined. Though they are usually enunciated in the lofty rubric
of social welfare, the objectives are to extract wealth from some groups and
bestow it upon others. Who gains and who loses depends on the relative political
clout of different groups. But the very fact that the goals are non-commercial
implies that there will be financial and economic losses, even if the agency were
otherwise efficiently run. Mcreover, its political nature guarantees that it
will be run to meet a variety of objectives, many of them noneconomic, as all
of its operations are ultimately judged by politicians, not by impersonal market
forces that force commercial enterprises to cut costs.
With some exceptions, parastatals are headed by political appointees.
Politicians universally interfere, often and arbitrarily, in everyday management
8 For example, when prices of an export crop fall, margins are reduced by
cutting costs. This means that produce. prices fall less than they
would if margins stayed constant.
71
decisions (Nellis, 1986). And the major decisions (such as pricing) are often
taken outside the control of the agency's management. All of these
characteristics make it inevitable that the operations will be inflexible and
inefficient. And, as the power of the state gives its agents (from purchasing
agents at the farmgate to top managers) the ability to make decisions that confer
financial gain or pain on others and on themselves, corruption and fraud are
inevitable as well. Finally, the de facto or de jure monopoly nature of the
parastatals, and the assurance that losses will be covered by the government
(either through direct budget transfers or through governmental guarantees when
parastatals borrow in commercial markets) ensures their immunity from incentives
to operate efficiently. Because these problems are inherent in their structure,
their resolution will require more than wreform," as that term has normally been
used.
Heaningful reform would require abolition of monopoly power, exposure to
competition, removal of government subsidies (including the underwriting of
commercial loans), and insulation from political pressures, as well as making
managers accountable and giving them incentives to operate efficiently and turn
a profit. But this would mean that the parastatals would no longer be
parastatals; they would be commercial enterprises. In other words, to be
reformed, parastatals must be liquidated or privatized. Concurrently, other
policy reforms could more efficiently meet some of the parastatal's social goals.
Food subsidies targeted to the poor, for example, could replace generally
subsidized food prices as a way to help the poor without burdening producers or
creating huge deficits.
A number of countries have undertaken piecemeal reforms such as allowing
some private sector competition, while still maintaining control of pricing
72
margins. Such reforms may be a step in the right direction, but the threat of
unfair competition from a parastatal with the resources of the government at its
disposal will always keep these Lqarkets from operating in a fully competitive
way. Only a handful of countries have begun serious reform of the type outlined
above. In Ghana, Mali, and Nigeria, export crop marketing boards have recently
been abolished and their functions privatized, with good results. Nigeria's
abolition of marketing boards fur palm oil, cocoa, rubber, cotton, and
groundnuts, together with exchange reforms in 1986, led almost immediately to
a 6 percent increase in cash crop production in 1987 in spite of bad weather.
Guyana has retained its marketing board in name only, completely changing its
role from directly intervening in the market to providing infornmation and export
brokerage services. The results have been favorable, though the chp,tic
conditions of the macroeconomy has been a serious constraint. Following a decade
of stagnation under government parastatal control, the banana sector in Belize
was completely privatized in early 1985. This generated a flurry of investment
and improved cultivation practices, with a consequent rise of production by 150
percent by 1987 and expansion still continuing. It is also noteworthy that the
most vibrant agricultural subsectors in many countries are those in which
governments have played little if any marketing role, such as fruits and
vegetables in Chile and Mexico, cut flowers in Colombia, and cocoa in Belize.
73
II. THE QUESTIONABLE GOAL OF PRICE STABILIZATION,
THE GOVERNMENT'S ROLE IN OUTPUT MARKETS
Objective of Price Stabilization
Governments' efforts to control domestic prices is euphemistically, but
almost universally, known as 'price stabilization.' Often the announced
intention to 'stabilize" price is little more than a smoke screen to obscure the
reality that prices are being systematically depressed or (on rare occasion)
raised. When the actual policy goal is to stabilize domestic prices--that is,
decrease domestic price fluctuations compared to world price fluctuations--the
rationale tends to be both to minimize the macroeconomic effects of international
price movements and to reduce the impact of price changes on producers and
consumers.
One effect of price movements of staple commodities (or 'wage goods') is
alleged to be a tendency to create or exacerbate inflation. This happens, the
argument goes, because increases in crop prices drive wages up and start an
inflationary spiral, while crop price decreases do not cause a symretric fall.
However, economic studies and investigations have failed to find such an
asymmetrical effect of crop price changes. A second effect of price
fluctuations comes from the resulting ups and downs in foreign exchange flows,
which could potentially destabilize fiscal and monetary policies and variables
if the commodity is an important export. When the foreign currency inflows
following a commodity boom cause the real exchange rate to appreciate so much
that it greatly disrupts other tradable goods sectors, the country is said to
have caught 'Dutch disease."
In examining actual case studies of countries whose exports are going
through boom-bust cycles, one finds that the macroeconomic problems sometimes
74
attributed to the commodity price fluctuations are really a result of
macroeconomic and trade policy choices (Box 3-1). In many countries, booms have
been accompanied by increased, rather than reduced, fiscal deficits and foreign
borrowing, turning what might have been a mild and appropriate appreciation of
the currency into full-blown Dutch disease. Studies have documented that
expansionary fiscal and monetary policy during and following commodity booms in
Nigeria (oil), Cote d'Ivoire (coffee and cocja) Senegal (phosphates), and
Colombia (coffee) have artificially overvalued exchange rates and devastated
agricultural sectors outside the booming commodity. Furthermore, whether or not
fluctuations in foreign exchange earnings are undesirable, stabilizing domestic
prices is likely to have only a marginal effect in reducing the magnitude or
adverse impact of exchange flows.9 'Price stabilization' often results in
destabilization of the government's budget which then leads to macroeconomic
problems, and (in the case of food imports) the balance of payments. The high
world prices of food grains in 1972-74 dramatically increased the food subsidy
budgets of countries that tried to maintain low domestic prices, such as
Bairg.adesh, Korea, Morocco, Pakistan, Sri Lanka, and Tanzania (World Bank, 1986)
BOX 3-1: COMMODITY BOOMS AND POLICY RESPONSE:
AGGRAVATING OR AMELIORATING THE "DUTCH DISEASE'
An often-expressed worry in developing countries is that concentration of
cxCu rt earnings in primary commodities subjects an economy to large shocks when
the commodities' international prices or domestic production rises or falls.
9 Stabilizing domestic prices of exports can have some effect on foreign
exchange flows in two ways. First, it keeps producers from fully
adjusting supplies to world price movements, preventing change in
production volume from magnifying the effects of price movements and
thereby making foreign exchange revenue slightly more stable. Second,
if stabilization is done by border taxes or subsidies, it may facilitate
countercyclical fiscal and monetary policy.
75
When export earnings increase precipitously as a result of price or production
changes, the result has come to be called 'Dutch disease," after the effect on
the Dutch economy of such increases in its natural gas exports. Increased
foreign exchange earnings, it is feared, will appreciate the real exchange rate.
reducing incomes in tradable goods' sectors outside the booming sector itself.
This expectation is correct, to one degree or another. But in spite of the
pejorative title, the "Dutch disease' per se is not bad. Exchange rar.e
appreciation sends the appropriate signal that domestic resource allocatio,ns
should probably change, with tradable sectors not producing the "boom" commodity
(notably agriculture, when oil or mineral prices boomed) contracting. How much
of a change actually takes place, of course, depends on how long the increase
in exchange earnings is expected to last, as well as such factors as whether
capital markets are sufficiently well developed to allow temporarily unprofitable
firms to borrow and stay in business during a period of currency appreciation.
What has often been more damaging to agriculture then the direct effect
of the increased earnings from the booming commodity, however, is the
government's policy response to the boom. Rather than using the windfall to
increase savings and investment (and possibly partially pay off existing external
debt) while following contractionary fiscal and monetary policies, many
governments have done exactly the opposite--spending lavishly on public
employment or questionable public subsidies. When the boom ends, governments
are left with large debts and expensive programs that are hard to cut back and
must be financed by inflationary budget deficits. Public investment institutions
are left with an atrophied apparatus for evaluating and selecting among potential
projects, since they were able to avoid hard choices when resources were
abundant.
In response to the coffee boom in 1976-80, government expenditure in
Colombia began growing rapidly in 1977 and accelerated even after world prices
peaked in 1980. The average growth rate over 1977-80 was 38.5 percent per yea:.
Mest of the increase was in government consumption, which rose from 7.7 per-cent
of GDP in 1977 to 10.1 percent in 1980. Government revenues grew modestly, and
the fiscal deficit expanded, financed mostly by external borrowing. Monetary
policy was expansionary. The net effect was an appreciation of the real
effective exchange rate (trade-weighted) by 30 percent between 1975 and 1982.
While the government's stated obiective was to diversify exports into non-coffee
agricultural and non-agricultural commodities, its actual macroeconomic pol;-ies
worked against this. Non-coffee exports fell from 7.7 percent of GDP in 1976
to 4.3 percent in 1983, completely reversing the diversification that had
occurred between 1967 and 1974. Other countries whose governmental spending
and borrowing policies have similarly exacerbated the impact of commodity booms
on agriculture and other tradable sectors include Mexico (oil), Nigeria (oil),
Cote d'Ivoire (coffee and cocoa), and Senegal (phosphates).
In addition to macroeconomic policy, trade policy also can exacerbate or
mitigate the effects of a boom. In a period of foreign exchange abundance, -zhere
is a natural tendency for consumers and producers to spend some of this on
increased imports. When quantitative restrictions on imports prevent this from
happening, the exchange rate appreciates even more than it otherwise would, with
the consequent negative effects on exportable sectors. The government's
restrictive trade policies at the beginning of the boonr, and reluctance to
76
liberalize even after it was well underway, was one factor contributing to
Colombia's steep appreciation. Trade restrictions may also create unforeseen
distributional consequences. In Kenya, higher coffee prices in 1976-79 were
initially reflected in higher producer income. But capital controls and
restrictions on imports geeatly increased the rents to suppliers of capital and
consumer goods, so much of the gain ended up going to urban areas.
The experience of a number of countries supports a conclusion that a more
appropriate policy environment--particularly tighter restraints on government
spending and fewer import restrictions--can prevent a mild appreciat on from
deteriorating into full-blown 'Dutch disease," or at least keep the patient out
of the emergency room.
Sources: D.L. Bevan, P. Collier, and J.W. Gunning, 1987, "Consequences of a
Commodity Boom in a Controlled Economy: Accumulation and
Redistribution in Kenya 1975-83," The World Bank Economic Review 1
(May); S. Devarajan and J. de Melo, 1987, 'Adjustment with a Fixed
Exchange Rate: Cameroon, Cote d'Ivoire, and Senegal," The World Bank
Economic Review 1 (May); W. Easterly and J. Cuddington, 1986,
'Management of Coffee Export Booms in Colombia."; B. Pinto, 1987,
"Nigeria During and After the Oil Boom: A Policy Comparison with
Indonesia," The World Bank Economic Review 1 (May); V. Thomas, 1985,
Linking Macroeconomic and Agricultural Policies for Adjustment and
Growth: The Colombian Experience, Baltimore, Md.: Johns Hopkins
University Press.
Most of the adverse microeconomic effects that are cited to justify price
stabilization have to do with the uncertainty created by price movements. To
the extent that various economic agents are risk averse, this added uncertainty
deters investment and reduces production. While economic theory is clear that
uncertainty acts as an added cost of production, the magnitude of the effect on
production is an empirical question, and the answer seems to be that the
measurable impact is small or non-existent. Regarding the investment effect,
most studies have found no relation between instability and aggregate investment
in the economy, though a few have found negative or positive relations.
There are major costs in price stabilization programs that are often not
recognized. Prices fluctuate because of changes in supply and demand. Each price
77
change sends a signal to every producer and every consumer. The price system
is an information system, and government cannot control prices without
engendering ignorance about the actual supply and demand for a product. If the
government misleads the public by understating the costs of a product, there will
be overconsumption; if government misleads producers by holding down the value
of a product, there will be underproduction. Either way, resources are
misallocated.
The benefits of intervening to forcibly stabilize prices are brought
further into question by the fact that price fluctuations are sometimes
predictable. When a freeze damages coffee trees in Brazil, for instance, coffee
producers in the rest of the world know from experience that world prices will
rise and stay high for a few years. There is little uncertainty. Farmers'
natural response to such movements is to increase fertilization, intensify
harvesting efforts, and adjust other practices to increase supply to the market
(and conversely, when prices predictably fall). Of course, if producer prices
are insulated from world price movements by domestic price stabilization, this
supply resporqe does not occur. While such insulation decreases the magnitudes
of foreign exchange fluctuations (footnote 9), it also lowers average profits
over the course of a price cycle, and makes the country poorer.10
Governments also use domestic price stabilization schemes to subsidize food
prices to consumers in years when world prices are high. This, however, is an
inefficient way of helping the pocr, since most of the subsidy goes to the middle
and upper classes. One study of the rice price subsidy in Peru concluded that
10 Countries whose exports of a commodity are constrained by international
agreement may need to lower average production, but even here, the most
efficient way to produce a given quantity of exports may be to reduce
the average price without affecting its variability.
78
36 percent of the subsidy benefitted the middle and upper classes (Nash, 1983).
Anecdotes from other countries--such am bread being used for animal feed in
Egypt--illustrate the wasteful folly of untargeted food subsidies. It also
increases the country's import dependency in the longer run by lowering the
average profit of farmers who grow the food crop. Better ways of targeting
subsidies are almost always possible. Finally it should be noted that to the
extent stabilizing a crop's price makes its produc'ion more attractive, it
discourages farmers from diversifying into other crops and adopting production
practices that reduce variability of yield, a strategy which in the long run
might be more effective in reducing risk.
Thus both the macro-and microeconomic foundations of price stabilizatior
policy are shaky at best. And in spite of their efforts to the contrary,
government sponsored stabilization programs--especially those for exports--often
actually make real domestic prices mora unstable than world prices (Box 3-2).
But the case for government-sponsored stabilization becomes even more tenuous
when the administrative costs and incidental effects of the stabilization
mechanisms themselves are considered. Although governments in a few countries
(e.g., Chile, Malaysia, Papua New Guinea) have relied mainly on burder taxes to
stabilize domestic prices, most have opted for elaborate and costly direct
intervention in agricultural markets, as the following section explains.
BOX 3-2: HOW SUCCESSFULLY DO GOVERNMENTS STABILIZE PRICES?
Almost all developing governments try to control the domestic producer and
consumer prices of important crops and food products, either directly, or
indirectly through parastatals or border tax measures. One of the professed
intentions of these efforts is to make price and producers' income fluctuations
smaller than they would be in the absence of control. How successful have the
schemes been in meeting this goal. To answer this question requires the
79
estimation of the hypothetical without stabilization schemes, instability of
price and income. For non-traded products, this would be a complicated task,
but for commodities that are imported or exported, the domestic price would be
roughly equal to the price on the international market converted to domestic
currency at the prevailing rate of exchange.1
Hypothetical price series were constructed for 15 crops across 37
developing countries (not all crops in all countries). Instability indexes of
these series were compared to indexes of series of actual domestic producer
prices for the corresponding crops and countries. (All prices were deflated by
a domestic price index before instability indexes were computed.) Both types
of price series were also combined with production data to yield series of
producer revenue with and without stabilization, z.nd instability indexes
constructed from these series. For each observation (price or producer revenue
for a crop in a country), the difference was taken between the instability index
with and without stabilization. Summary statistics across all observations,
divided by pioduct group, are reported below in Table 3-2-1.
TABLE 3-2-1: S-nary Statistics for Differences
In Instability of Variables A and B
A: °roducer Price Producer Revenue
B: Border Equivalent Border Equivalent
Price Producer Revenue
Grain Mean -15.0 -12.0
(89 obs.) Std. dev. 12.7 13.1
Beverage Mean -6.9 -5.4
(29 obs.) Std. dev. 13.4 12.6
Fiber Mean -3.9 -2.5
(21 obs.) Std. dev. 11.3 12.8
Source: 0. Knudsen and J. Nash, 1990, 'Domestic Price Stabilization in
Developing Countries," Economic Development and Cultural Change, 38
(April) :539-58. Instat1lity indices calculated on basis on FAO price
dt-A.e
For each product category, the with-stabilization variable was on average
more stable that the hypothetical without-stabilization variable, as indicated
by the fact that the mean difference was negative. It is also nioteworthy,
however, that the size of this average reduction is small relative to the
so
standard deviation within the sample. In other words, for a sizable fraction
of the cases, actual domestic prices and producer revenues were less stable than
they would have been in the absence of any attempt to stabilize them. For
grains, this was true for 9 percent of the pr4ce observations and 15 percent of
the revenue observations. Corresponding figures for beverages are 31 and 31;
and for fibers 35 and 38. (The latter two categories are mainly exports from
developing countries, while grains are mainly imports.) Given the high costs
of the stabilization schemes used, they have failed in their objective in a
remarkably high percentage of cases.
1. Changes in marketing margins are only a minor source of instability,
relative to movements in world prices and exchange rates, so margins are
assumed to be constant.
Trade Policy
The necessary coroilar;^ to pricing policies that cause domestic prices to
deviate from their international levels is restricting trade with the outside
world. This is often done by giving a parastatal marketer exclusive authority
to import or export the crop. But even where this is not done (and sometimes
even where it is), governments impose a variety of other controls on
interr.ational trade in agricultural products.
Commonly, both imports and exports are taxed, with the volume of trade in
many products closely controlled and restricted by requirements that licenses
be obtained froi overnment ministries. Venezuela is not unusual; before the
trade reform progLam bega.; in June 1989, only 5 percent of all agricultural (and
9 percent of agroindustrial) product categories in the tariff schedule were free
of some restrictions. (Tariffs are not counted here as restrictions.) Imports
of 20 percent of the agricultural (and 30 percent of the agroindustrial) products
were prohibited altugether. In a large sample of developing countries, about
48 percent of food items and 37 percent of agricultural raw materials are
81
affected by such nontariff measures (Erzan, et. al., 1988). The effect (and
probably the real purpose) of such restrictions is often to partially compensate
for the anti-agriculturEl bias implicit in policies of exchange overvaluation
and industrial protection, though the public justification is usually to promote
self-sufficiency in food.
Such restrictive tendencies of policy-makers have been reinforced by the
industrial countries' agricultural policies that have depressed and destabilized
prices of major food crops. Developing country governments restrict imports
because they believe, with some justification, that if cheap imports were freely
allowed, the effect on local agriculture would be devastating. However, two
points get lost in the political rhetoric about protecting local farmers from
unfair competition. One is that the government's own exchange rate and
industrial policies create much more serious problems for agriculture than would
external competition, even from subsidized products. The other is that import
prices are "unfair" because they are a gift subsidized by taxpayers in industrial
countries. An importing country that duts not accept the gift ends up producing
the product at a cost higher than its import price. It may be better to accept
the gift, allowing the agricultural sector (or certain agricultural subsectors)
to contract and release resources to be used more productively in other sectors
(or agricultural subsectors).11
11 The issues here are complicated. Industrial country policies may be
temporary, which, given costs of adjustment, might imply that resources
should not leave the agricultural sector, only to come back when the
subsidies are eliminated. Even this possibility, however, does not
necessarily call for artificial incentives to keep the sector from
contracting. There is little reason to think that governments are
better predictors than the private sector of whether and when subsidies
will be eliminated.
82
But, such economic arguments seem unlikely to carry the day in the face
of political diatribes made possible by the industrial world's subsidies. And,
even though trade restrictions imposed against subsidized agricultural exports
may not make economic sense from an individual developing country's point of
view, they may have the same collective economic rationale as do the GATT-
sanctioned restrictions on imports of subsidized manufactured exports. That is,
if all or most countries impose such restrictions, it will make it more costly
for the exporting countries to subsidize the exports in the first place, thereby
deterring the subsidies, which are themselves economically inefficient on a
global level.
Restrictions and taxes when applied to exports have the effect of keeping
domestic prices low. In many countries, the major pv pose is to raise revenue
for the government by taxing export producers. In others, the policies are aimed
at keeping domestic prices low for consumers (beef in Mexico) or agroindustrial
processors (cotton in Venezuela, logs in Belize). Sometimes the export
restrictions are made necessary by subsidies that make domestic food prices lower
than world market prices. When price differences are large, of course, the
restrictions are widely evaded. In Venezuela, a number of products were so
heavily subsidized that as much as 20 to 35 percent of apparent consumption was
actually contraband, despite export prohibitions. The negative effect of
depressing export prices is discussed in section B.2.a. But trade restrictions
have negative effects that go beyond their impact on prices. The licensing
procedure itself typically imposes an onerous burden. In Madagascar, despite
recent trade policy reforms, exporters still are required to have 51 documents
stamped and verified three times, on average. An average shipment requires three
83
man-days just for the paperwork. Giving bureaucrats such extensive power also
fuels rent-seeking and corruption, further discouraging exporters.
Many governments provide heavy protection to the agroindustrial sector by
tariffs, nontariff trade barriers, or export incentives with the professed
intention of benefitting domestic farmers. In reality, a given level of
protection on agroindustrial production gives a higher level of true effective
protection for activities with a low domestic value added than for activities
with a high domestic content.12 Thus, the links forged with local agriculture
tend to be quite limited. Instead, this trade policy produces agroindustry based
entirely on imported inputs. In the Caribbean, for example, agroindustry tends
to be either very capital intensive, with a domestic content of 6 to 10 percent,
or quite intensive in labor and domestic raw materials, with domestic content
of 80 percent or more. The protection for agroindustry tends to favor the former
and produces such anomalies as a large soybean crushing industry in Trinidad and
Tobago, and wheat millers in a number of tiny Caribbean islands.
12 As an example, consider two hypothetical agro-industries. Industry A
imports oil-seeds and extracts the oil for local consumption. It relies
on imported capital equipment, raw material, and intermediaLe inputs
(fuel, lubricants, chemicals, etc.), so only, say 10 percent of the
price of the final product is either cost of local nontradable inputs
(e.g., labor) or profits. That is, domestic value added is 10 percent.
Industry B processes fruits (which are not of export quality) into jelly
for the local market Since the process does not require elaborate
machinery or imported raw mate-ials, the domestic value added is, say 80
percent. Now, suppose t;hat imported inputs are not taxed and consider
the effect of a 20 percent tariff on imports of both edihle oil. 8nr.
jelly. The tariff will raise the domestic price of both by 20 peLcenL.
But, since the domestic context of A is much smaller than that of B, the
20 percent rise in the price of the product is reflected in a much
larger rise in the return to the domestic inputs and higher profits in
industry A. In this example, the equal tariff gives an effective
protection rate of 200 percent to oil production and 25 percent to
jelly-making.
84
III. SUBSIDIZING THE LARGE FARMER:
THE GOVERNMENT'S ROLE IN INPUT MARKETS
Governments have often tried to compensate for explicit or implicit taxes
on agriculture by providing inputs--fertilizer, credit, irrigation services,
improved seeds, and electricity--at subsidized prices. These subsidies, which
by definition are distributed in proportion to the products' sales, have done
little if anything to compensate the poorest farmers, who use few purchased
inputs, produce relatively small saleable surpluses, and are not well enough
connected to be allocated a fair share of inputs whose shortages are created by
the system (e.g., credit). One study in Morocco found 70 percent of the
subsidies benefiting the richest farmers (Seddon, 1989). Instead of helping the
poor, subsidies have misallacated resources, skewed rural income distribution,
imposed a burden on the fisc, and sometimes encouraged environmental degradation.
Fertilizer Subsidies
Most developing countries subsidize the use of fertilizer by making the
selling price lower than costs of producing (or importing) and distributing it.
The implicit agenda here is the same as with other input subsidies: maintain
tarmers' political support by (partalaly) compensating them for the policies that
depress their output prices. Thc public justif.caticn is gencrally couched in
terms of encouraging farmers to take advantage of the higher yields that
fertilizcrs prod-ce. Rc-phrasod _.i. a _ay Ic. flatt.erin. to farmers, the idca
is that since farmers are too backward to understand that expenditure on
fertilizer pays off handsomely in higher profits, thev would be unwilling to buy
much of it if they had to pay as much as it costs to produce. This paternalistic
85
attitude is just one manifestation of the general government view in developing
countries that rural residents are irrationally unresponsive to financial
incentives. While such myths have long ago been de-bunked by serious studies
(see, for example, Schultz, 1964), this notion continues to form the basis for
fertilizer pricing policy in many countries.
There is little question that these subsidies have at least partially
achieved their ostensible objective; fertilizer use has been increased. But the
cost has been high in a number of respects. The most obvious cost is the burden
upon the fisc. Table 3-2 shows estimates of the size of subsidies relative to
total price, the agricultural budget, and GDP in some countries for which data
is available. As this last comparison makes clear, the size of the subsidy is
large enough to have significant adverse consequences for the fiscal deficit and
macroeconomic variables in most of these countries. Subsidies that ranged from
0.4 to over 1 percent of GDP in soma countries obviously added inflationary
pressure to economies that could ill afford it.
On a microeconomic level, underpricing of fertilizer, as with any product,
results in inefficiently intensive use. When fertilizer is priced at $1 per
pound (assuming a subsidy of 50 percent of the border price of $2) farmers will
apply cnough of it so that the value the marginal pound adds to production is
$1, in spite of the fact that the pound of fertilizer costs society $2 to produce
or import. While aggregate quantitative estimates of this kind of loss are
difficult to make, it is clear that subsidies that in most cases exceed 50
percent. and in some cases approach 95 percent, produce large distortions and
thereford large costs. ,urthermore, overuse of fertilizer has environmental
effects. In some areas, it poisons groundwater and runs off into rivers or
coastal areas, where it damages wildlife habitat and fisheries.
86
The costs of the subsidies are further magnified by the way in which they
are administered. Production, distribution, and importation are frequently
handled by inefficient parastatal organizations that have limited incentives to
achieve cost savings, since losses are covered by the government. One study
estimated that the public sector fertilizer plants in India are only 40 percent
as productive as private sector plants (Srinivasan, 1986). Imports are
controlled by the government in ways that limit the competition and pressure for
efficiency that free imports would provide.
In some ways, p3licies seem obsessed with uniformity. Prices (or margins)
are often uniform across locations and seasons, regardless of the different costs
of storing and delivering the fertilizer to farms. This encourages use in
uneconomic locations and seasons. In India, it also meant that dealers tended
to deliver fertilizer only when they could do it cheaply, reducing fertilizer
availability at other times (Narayan, 1986). Often only one or a few varieties
of fertilizer are available, forcing farmers to uGe the same kind on crops with
different needs. A study in Senegal compared the standard fertilizer sold by
the parastatal with more appropriate mixes, and found that equal yields could
have been achieved at 20 percent lower cost if bette: blends had been available.
Yet in other ways, r--n-unfrm. t;s the ;-e. The degree ^f subsidy often
depends on the type (f fertilizer, the type cf crop to which it is to be applied,
or the identity cf the target user, further distorting incentives. This
sometimes works against othe: worthwhile goals: in Colombia, the only crop for
which fertilizer subsidies dLe av.i,e is coffee, Lheity Uii?Ale L.ii iaki the
attempt to diversify production. It also leads to diversion; in Malawi,
estimates of leakages range from 10 to 25 percent (Lele and Meyers, 1987). The
private sector can seldom compete with the subsidized operation of the parastatal
87
in making or distributing fertilizer, even where there are no legal sanctions
for doing so. Thus, the private sector is crowded out, and farmers are left
without a reliable distribution network, as one study found in Morocco (Seddon,
1989).
TABLE 3-2: Fertilizer Subsidies in Selected Countries*
As Z of As 2 of As Z of
Country Years(s) Price Ag. Budget GDP
Colombia 1983 8
Cote d'Ivoire 1980 60-100 5 0.2
Egypt 1984 46-76
Gambia 1983-84 61-96 2
Hungary 1980-84 0.7
India 1980-85 0.4
Indonesia 1983-84 34-45
Mexico 1986 0.4
Nepal 1980-83 0.3
Nigeria 1980-83 75 32.1 (1985) 0.2
Pakistan 1980-84 0.7
Philippines 1980-81 a/ 0.1
Sri Lanka 1981-83 57-74 (198) 1.0
Tanzania 1981-82 83 0.4
Turkey 1980-83 80 (1980-84) 1.0
Venezuela 1984 50 8 0.1
1987 0.4
Zambia 1980-84 1-25 29 0.4
a/ Subsidies abolished mid-1982.
*Sources: Seguro, et. al., 1986; Harris, 1984; World Bank, 1988; Lele and
Christianson, 1988.
Irrigation
Irrigation has been the single largest investment expenditure in
agriculture. The International Food Policy Research Institute estimated that
It would acco_nt u,z ov.. ha'f c al' a;,-u'tural investment in the 1980s in
36 important developing countries. Despite this emphasis, results have been
disappointing, whether compared to what was projected, what is technically
achievable, or what is produced under private irrigation schemes. Many of the
88
problems are traceable to the policy environments in which the investments were
made, particularly the pricing of water at rates far too low to recover costs.
In few countries do water charges come close to covering even the costs
of operating and maintaining the irrigation system, much less servicing the
capital costs to build it. In a group of 7 Asian countries for which such
estimates are available (Bangladesh, Indonesia, Korea, Nepal, Pakistan, the
Philippines, and Thailand), operation and maintenance costs exceed user charges
in every country except the Philippines. On average, these costs were 2.2 times
charges. Total capital and recurrent costs were an average of 9.6 to 16.2 times
charges, depending on how the costs were estimated. In Mexico, the average
recovery of operation and maintenance was 70 percent between 1952 and 1970, but
had deteriorated to 36 percent by 1986 (World Bank, 1989) while in Venezuela in
1987, the recovery rate was estimated at no more than 10 percent, since nominal
water charges had not changed in more than 20 years. In a sample of World Bank
projects, revenues covered only 7 percent of project costs.
In most developing countries, charges cover no more than 10 to 20 percent
of the full cost of delivering the water (Postel, 1989). Providing a valuable
resource at giveaway prices has a number of unJesirable consequences. One of
the most obvious is the incentive this creates for inefficient overuse of water.
Farmers sometimes flood fields in Sri Lanka. for example, as a substitute for
weeding (Chambers, 1977). There are no incentives to design projects, or for
users to behave, so as to conserve such a cheap (to farmers, that is, but not
to the economies) resottrce. Cnnsequentlv, only 25 to 30 percent of the water
diverted is typically available for use on the farm (Rangley, 1987). Even less
is available to the users near the lower reaches of the system, since those near
the head take all they can possibly use. This overuse of water in the fields,
89
as well as the large quantities that leak from damaged or obstructed canals in
transit, wreak environmental havoc. In India, 10 million acres of cultivable
land have been lost through waterlogging, with another 25 million threatened by
salinization, another consequence of overuse (Jayal, 1985). In Pakistan, 12
million acres are waterlogged and 10 million saline (World Bank, 1982). Pakistan
devotes half its irrigation budget to mitigating the salinization (Postel, 1989).
In Peru, 25 percent of the 80,000 irrigated hectares in the productive coast area
have salinity problems. It is estimated that salinization in Mexico reduLds crop
output by the equivalent of 1 million tons of grain per year - enough to feed
5 million people (Postel, 1989). Worldwide, FAO estimates that half of all
irrigated land is salinized to the extent that yields are decreased (Carruthers,
1983).
Less obvious are the undesirable effects of the enormous rents created by
these policies. The "rents" are just another aspect of the underpricing: when
the benefits to the farmer are 3 to 20 times what he is charged there are
tremendous incentives to spend resources to take full advantage of the bonanza.
One consequence is corruption of the system operators that control who gets the
cheap water. Operators sometimes oppose and circumvent efforts to publicize
operating ru'les and schedules, since this limits their discretion. At times,
they create artificial shortages to increase their clout (Bottrall, 1978). The
politically powerful and well-to-do are the main beneficiaries of cheap
irrigation all over the world, not only becaube they have more land to irrigate
but also because they are better equipped to lobby for preferential treatmrant
in des.gn and operation. Irrigation tends to widen, rather than reduce, income
disparities, as studies in Mexico, India, and Indonesia have shown (World Bank,
1983: Rao. 1985; Small, 1986).
90
The underpricing distorts project design decisions as well. Politicians
anxious to dole out as much patronage as possible pressure for extensive projects
that cover far more area than could be economically justified. Irrigation
pros' cts the world over thus have been implicated in aquatic and forest habitat
destruction (and consequent destruction of fisheries when eroded soil smothers
coastal breeding areas), seawater intrusion into rivers, and creation of breeding
grounds for disease and agricultural pests (Goldsmith and Hilgard, 1986; Pelts,
1984; Nair, 1985). New projects that create more patronage are preferred to
rehabilitation of existing ones. (In contrast, in the Philippines, where user
groups must repay part of the construction costs, the farmers exert pressure for
mirimalist design - Small, 1986). And since pricing does not guide users'
decisions, consumption gives no guidance to project designers on how projects
should be designed. Once built, dual use projects tend not to be operated for
the benefit of agricultural water users, since the low prices would make the
project appear to be uneconomical. Rather, they are operated so as to maximize
power generation, making the project look financially successful, as has been
documented in North India (Reidinger, 1974).
Finally, the underpricing means that projects must be funded from general
Apart from the otvkios financial burden thic imposes, it has other
ilsiqfio,us effects. It implies, for example, that irrigatioi, a-eiucies are nut
answerable to farmers. To the contrary, in irrigated areas in some countries,
the tarmers are little more Lhaui state employees, since the government maKes
all .mporta;.t prodLction decisions, as in.r.1rocco (Seddon, 1989). Comparative
studies in the Philippines, Korea, and China have found, r,ot surprisingly, that
agency staffs are more responsive to farmer needs when their funding comes from
the farners (Small, 1986; Nickun, 1982; World Bank, 1982; Wade, 1982). And,
91
conversely, when farmers feel their needs are met, they are more willing to
contribute to funding the system. Thus, farmers are willinig to pay handsomely
for private irrigation systems they control. Funding from the Treasury rather
than from users also means that both operation and maintenance and new
construction tend to be slighted during periods of austerity, as in the 1980s.
Many systems now suffer from inadequate maintenance and years of neglect. In
contrast, in the Philippines, where the National Irrigation Agency is funded
completely by revenues from users, farmers participate in decision-making, the
infrastructure functions well, and rice yields have increased impressively
(Postel, 1989).
Credit
Providing cheap credit to farmers has been a major way of subsidizing
production and shoring up political support in rural areas. But the strategy
is costly and ineffective. Typically, credit is provided to a large extent by
donors and channelled through special government lending institutions. The rates
charged are below commercial rates and in inflationary environments are often
lower than the rate of inflation, making returi,s negative in real terms.
Political and other considerations make it difficult to take action to collect
delinquent loans, resulting in high default rates, typically between 20 and 50
percent, but sometimes rising as high as 80 percent (Feder, et. al., 1989). The
direct budgetary cost of these policies is e: -.ordinarily high by any measure.
Estimates of the credit subsidies from negative real rates alone (not including
default co.ts) for six Latin American countries show that the subsidies have at
times exceeded government expenditures on research, extension, irrigation, land
reform, and education and health in rural areas (Elias, 1985). In the late
92
1970s, credit subsidies in Brazil exceeded 5 percent of GDP (World Bank, 1986).
In Mexico, the cost to the government over an extended time has been greater than
the total amount lent. Subsidies have been estimated at 0.7 percent of GDP in
Mexico, 0.2 percent of GDP in Venezuela and up to 0.3 percent of GDP in Jamaica
(World Bank, 1989; Knudsen, 1989; World Bank, 1990). In Asia, where lower
inflation makes negative real rates less of a problem, the default costs have
been high -- 50 percent in Thailand and India, 40 in Malaysia and Nepal, and 71
in Bangladesh (Feder, et. al., 1989). These costs either inflate governmental
budget deficits, or, when commercial banks are forced to absorb them, are
reflected in very high. rates for unsubsidized loans. Subsidies also keep deposit
rates low, both in order to reduce the cost of the subsidy and to discourage
borrowers from just re-depositing their loans to earn the interest.
The government involvement in rural credit is based on the perception that
otherwise credit would be unavailable or available only at exploitative rates.
Yet when surveys have been done, it turns out that most farmers have access to
other sources of credit, and the informal credit markets are competitive, not
monopolistic (Harris, 1983; Singh, 1983; Wells, 1983). The high rates of
interest charged by informal lenders turn out to be due to high transaction costs
on small loans. (Administrative costs for small and medium loans can reach 20
percent of the loan amount.) The government institutions cannot avoid these
costs, but often fail to pass them on to borrowers, further increasing the real
subsidy.
Commercial lenders, of course, cannot match the subsidized rates and are
crowded out of the market. While experience in India, Indonesia, Korea, Kenya
and other African countries has shown that even small farmers can mobilize
savings when they have good investment opportunities (AFTAG, 1989; Wague, 1988;
93
Cuevas, 1988; World Bank, 1986), subsidized ,.redit programs discourage
development of viable rural savings institutions. Thus, the apparent shortage
of credit is largely illusory. The problem is caused in large measure by the
institutions whose raison d'etre is to solve the probleml Where true rural
financial institutions have been treated with benign neglect, they have thrived.
Savings in rural credit unions in Cameroon grew at an average rate of 25 percent
per year in 1982-87, while the formal banking sector was in trouble (World Bank,
1989). The experiences of 'Banques Populaires' in Rwanda and other rural credit
institutions in Benin, Burundi, Cote d'Ivoire, and Togo have been similar. I.
the Philippines, rural credit markets have developed through sellers of farm
implements, most of whom were previously farmers. These credit markets have been
very flexible and efficient in meeting farmer needs.
Credit has proven to be an ineffective vehicle for achieving the intended
objectives of increasing production or helping small farmers. One major problem
is that money is fungible; once lent, it can be (and often is) spent for
non-agricultural investment or consumption. This makes credit a poor way of
redressing the anti-agricultural bias created by policies that depress output
prices; low output prices make returns low on agricultural investment, increasing
incentives to divert the funds to other uses. Studies in Mexico, Pakistan, and
the Philippines showed that only 25 to 50 percent of loan funds went to increase
agricultural investment.
Most of the subsidies are windfalls to large farmers, not small- holders.
As with all subsidies to inputs, large farmers benefit most because they use the
most inputs. But other characteristics of the credit market work to reinforce
the bias against small borrowers. Because there is not enough credit to meet
the demand at the low interest rate, the money must be rationed. Making a few
94
large loans instead of many small ones is a way of minimizing the institution'.
administrative costs and risks and so is the preferred way of rationing the
limited supply (Braverman and Guasch, 1989). From the demand side, the high
fixed transactions costs in government-run credit markets make it cheaper for
small borrowers to go to the informal market. In Bangladesh, for example, the
Lotal effective cost (including transaction and interest costs) foL small loans
is 146 to 169 percent in the formal market, but only 57 to 86 percent in the
informal (Ahmed, 1989). Another cross-country study estimated transaction costs
to be up to 245 percent of the official interest rate for small loans, but 3 to
56 percent for large ones (Cuevas, 1988), indicating the seriousness of the bias
against small borrowers. In the formal credit market in Bolivia, borrowers must
incur costs of 18 percent of the loan amount even before knowing if the loan
would be approved, compared to a cost of 8 percent in the informal market
(Ladman, 1984).
Making credit cheaper, in addition to draining the treasury, has the
unintended consequence of making capital cheaper relative to labor. Predictably,
this leads to a shift to less labor-intensive production. One study showed that
in India the main effect of the availability of cheap credit was the substitution
of purchased inputs and machinery for labor, with only a small impact on output
(Binswanger, et. al., 1989). Such changes in production techniques further
impoverish rural landless workers, who are the poorest of the poor in most
societies.
95
IV. SUBSIDIZING THE PRESENT WITH THE FUTURE: EFFECTS OF GOVERNMENT POLICIES
ON PUBLIC INVESTMENT (OR HOW TO MAKE PORK OUT OF 'WHITE ELEPHANTS)
Well-designed public investment can complement private investment and
contribute greatly to increasing productivity in agriculture and other sectors.
Improving infrastructure, doing basic research, disseminating information helps
lubricate the economy and aids private agents in maximizing output of the most
valuable products and responding flexibly and intelligently to new investment
opportunities. But the sad fact is that public investment portfolios have
suffered ill effects from periods of both boom and bust.
In the periods when foreign exchange was readily available (from booming
commodity exports and external credit), particularly in the 1970s and early
1980s, public investment budgets expanded rapidly along with other government
expenditure, and became bloated with unproductive large-scale 'white elephants."
These provided high visibility for politicians and made good "pork barrel"
projects for local constituents, but had poorer rates of return than alternative
investments. Sometimes the low rateb of return were due to the use by the
government of investments to discriminate in favor of certain regions, as in
Kenya, where four large projects consumed half of agriculture's development
expenditure and crowded out investments in agricultural research, rural physical
infrastructure, and human capital. An ex post evaluation of the World Bank's
agricultural investments in this period in 6 African countries showed 36 percent
(by value) had negative economic rates of return (including 72 percent of the
projects in Tanzania), while another 18 percent had positive rates of return less
than 10 percent, which is certainly less than the opportunity cost of capital
(Lele and Meyers, 1987). (Even this bleak picture probably overstates the value
96
of the whole investment budget, since projects by the Bank are presumably
subjected to more stringent scrutiny than average.) An analysis of Mexico's
agricultural investment portfolio in 1986 (even after a considerable degree of
retrenchment) showed 26 percent of the projects were uneconomic, with a benefit-
cost ratio less than one (World Bank, 1989).
Another unfortunate result of the expansion of public budgets in this
period, and a characteristic that would later haunt agricultural investment
budgets, was the large and rapidly rising public sector payroll. In Mexico,
public employment increased by 700,000, between 1981 and 1984, before reductions
began in 1985. As a result of a major push for food self-sufficiency, the
Ministry of Agriculture swelled to 152,000 staff, with 22 percent located in
Mexico City, far removed from the farm community. In Tanzania in the mid-to-
late 19709, public sector employment was growing at 15-16 percent per year (Lele
and Meyers). Much of the growth in payrolls in many countries was concentrated
in the parastatals. In Tanzania, 70 percent of public sector employees were
working for the parastatals; only 10 percent were involved in providing basic
services in the Ministry of Agriculture, in spite of the fact that agriculture
accounted for around 52 percent of GDP and 80-85 percent of employment in the
early 1980s.
In the 1980s, rising interest payments and declining capital flows forced
governments to cut spending. But the expenditure cuts were not made "across the
board"--some cuts were politically easier to make than others. Government
payrolls were hard to pare down, as were transfers to money-losing parastatals.
Consequently, the capital budget got squeezed the hardest. Thus, in a sample
97
of 24 countries' expenditure cuts from 1974-84,11 capital expenditures fell by
about 28 percent, while subsidies (including transfers to parastatals) fell by
only 11 percent and the public sector wage bill by 14 percent (Hicks, 1988).
By sector, the steepest declines were in infrastructure (25 percent) and the
productive sectors (19 percent), while defense and social sector spending
declined by only 7 and 11 percent. Even within the capital budget,
infrastructure and the productive sectors declined the most (41 and 42 percent).
Thus, investment in these areas was a declining part of the capital budget, which
was a declining part of the overall budget, which was itself declining.
Undoubtedly, sone relatively unproductive investment projects got cut in
this procecs. But it is also clear that the squeeze hit hard at maintenance and
rehabilitation budgeLs (which always tend to be low priority because of their
low visibility) and at many guod investments. Cross-country information on
exactly what happened to spending on different categories within the agricultural
budget is hard to come by. But Mexico's pattern does not seem to be atypical.
There, the agricultural budget fell in real terms by 1987 to 26 percent of its
level in 1981. In the meantime, only late in the game (1985) was action taken
to begin unloading some of the 89 parastatals (most of them a budgetary drain)
under the control of the Ministry of Agriculture. Spending on specific programs
within the agricultural budget in 1987 as a percentage of 1981 levels was as
follows: administration, 28; technical assistance, 21; university, 35;
irrigation, 26; rehabilitation, 13; livestock, 19; forestry, 44; research, 41;
urban water conduction and storage, 24. Of all categoAies, rehabilitation was
hit the hardest.
13 Results were very similar in another smaller sample of countries' cuts
between 1979 and 1985.
98
Venezuela's agricultural budget has also shown a strong bxis toward cutting
investment (mostly irrigation and rural roads) rather than current spending.
There, a budgetary cut of 61 percent in nominal terms between 1987 and 1989 was
achieved by reducing investment by 95 percent, while current spending grew by
55 percent (World Bank, 1990). To a very large extent, the cuts in investment
.were made to continue the subsidies (mainly to fertilizer and credit) and support
for public sector financial institutions, which together by 1988 accounted for
55 percent of the agricultural budget. Rural infrastructure expenditures were
only 35 percent of amounts budgeted for them. Because of similar patterns
throughout the region, agricultural engineers familiar with Latin America
estimate that about 70 percent of irrigation schemes suffer from significant
deterioration because of lack of maintenance.
99
CHAPTER 4
R EFINING THE ROLE OF GOVERNMENT IN AGRICULTURE
The first three chapters of this monograph have shown how government policy
in agriculture has been Lostly and misdirected both in developed and developing
countries. In developed countries, it has cost the world's taxpayers and
consumers hundreds of billions of dollars yet has failed to provide low cost food
while sustaining farm incomes. Furthermore, it has disrupted world trade and
threatens to lead to future divisive trade conflicts that could have
ramifications well beyond agriculture. It has enriched larger farmers and agro-
industrialists and probably accelerated the replacement of the family farm with
large farm businesses. Possibly most important in the long run, it has
contributed to the degradation oi the environment--through soil erosion, as well
as pollution of streams and rivers and ground water. In developing countries,
it has impoverished rural people while not providing the food security desired
by urban consumers and policymakers. The immense funding that has gone to
subsidize fertilizer, credit, and urban consumers should have gone to developing
infrastructure and providing education. health and other services for the poor.
Instead it has been largely wasted and unfortunately is irrecoverable.
This need not continue. Many governments are dissatisfied with their
agricultural policies and the costs that they induce. Multilateral negotiations
in the Uruguay Round will hopefully establish once and for all that trade in
agricultural commodities should be treated like that of all other commodities
and made subject to the full disciplines of the GATT. Unfortunately, to bring
agriculture fully into the GATT will be politically difficult. And it cannot
be left to industrial countries alone. Developing countries have a role in
100
bringing this reform about. But it requires changes in how the role of
government in agriculture is perceived and how developing countries participate
in the GATT.
Redefining the Role of the Government
Many of the unproductive policies described in earlier chapters share a
common cause--a tendency by governments in both developing and developed
countries to regard any perceived problem as potentially resolvable by taking
income from some and giving it to others. This problem is very bas.c; the issue
is far more profound than would be implied by the terms in which policies are
usually discussed. It is not enough just to recognize, for example, that all
of the interventions described in 'arlier chapters have costs and acknowledge
that they should be subjected to - ..ne cost-benefit criteria. Nor it is generally
sufficient to eliminate the legal monopoly of a parastatal. The political
pressures that generated the detrimental policies or the monopoly power remain
in place, largely unchecked. Cost-benefit evaluations can be manipulated
(especially when factors such as effects on income distribution, regional
development, and self-sufficiency are considered legitimate costs or benefits),
and pricing policies of parastatals can create de facto monopolies by driving
out the private sector, even if there are no legal barriers to entry. Thus, as
long as government actions remain unconstrained by basic changes, the outcomes
are not likely to be significantly changed by superficial reforms. What is
needed is a re-consideration of the government's proper role in agriculture,
with the consequent institutional changes. A solution to the problem requires
withdrawal of most government intervention from agricultural markets and
recognition of economic rights--for farmerr to produce whatever commodities
101
using fficient technologies they feel will best profit them and sell their
products freely at home or abroad; for traders to move goods in the expectations
of profits unconstrained by fear of repression; and for consumers to buy foods
at the lowest prices, whether from foreign or domestic sources.
BOX 4.1: COW HORMONES: WOE TO THE CONSUMER LEST HE BENEFIT
Cow hormones (bovine somatotropin) offer the potential to substantiating
increase milk production. Although some consumer groups contend that the use
of hormones has not been adequately tested for potential health effects on humans
that drink milk, the Food and Drug Administration has found the milk safe.
Nevertheless, the United States No. 1 dairy state has prohibited its use until
at least June 1, 1991. The Washington Post (April 28, 1990) states the real
reason for the ban: "opponents of the hormone said that the potential 10 to 25
percent increase in milk production and resultant lower milk prices would harm
family dairy farms.' Of course, it would benefit consumers of milk, but as with
most farm programs they must be protected at (almost) any cost from lower prices.
Yet, the dairy lobby fears that the falling prices of milk would disrupt the
dairy price support program. Thrre are also concerns that, if milk becomes more
plentiful, public support for a government program to assure plentiful supplies
of milk will decrease.
A re-examination of the government's role in agriculture should start with
not only a concept of these rights, but also with recognition that when
individuals are allowed to transact freely, the resulting markets work quite
well, with a few exceptions. Even in the case of those exceptions, before a
decision is taken to intervene, it is necessary to ask whether the government
failures are likely to be more serious than the market failures. Though markets
have their weaknesses, markets have not resulted in paying farmers to leave idle
60 million acres (as the United States government did), or in letting mountains
of butter slowly rot (as the European Community does). Nor would the market
send a signal to the farmers of Ethiopia to absolutely avoid storing any of their
102
surplus grain, or to the farmers of India to drown their crops in too much water,
or to the farmers of Brazil to slash and burn :ain forests to graze cattle.
The best case for intervention is in activities for which individuals do
not absorb the full costs or benefits of their actions, that is, where there
are significant externalities. In agriculture, this includes carrying out or
sponsoring either basic research or applied research that leads to the
development of inputs or techniques that could not (realistically, be patented.
Governments all over the world carry out this function, though many extend their
research activities into areas where private markets could be expected to work
well if given a chance (and do work well in some developed countries), since the
resulting products could be patented and privately marketed--hybrid seed, for
example, or mecharical production hardware. And, even in research, the need
for government intervention may be decreasing. In the United States, private
companies already conduct 74 percent of all agriculture research, and the role
of private companies is expected to increase as issues like patenting new forms
of biotechnology are resolved. While much of the 1 rrnment's research funding
is distributed by members of Congress to their constituents, based mainly on
political connections and not necessarily merits, private research is directed
only at achieving the maximum return on the investment.
Another area in which individuals do not fully absorb the cost of their
actions is activities with environmental effects. Farmers that over-use
pesticides or fertilizers or that allow their land to erode impose significant
costs on fisheries and tourism in some countries, since the runoff poisons or
smothers coral reefs, estuaries, and other breeding and juvenile rearing areas;
over-pumping of groundwater for irrigation lowers the water table and raises
costs for others. So far, the role of government policies in controlling these
103
problems has been predominantly negative. Policies that underpriced inputs or
artificially promoted production have encouraged overus.e. And failure to
recognize individual property rights in some countries removes a farmer's
incentive to invest in anti-erosion farming techniques to ensure the long-term
viability of the farm. Governments should reform their policy to put primary
emphasis on the goal of preventing environmental degradation. Then the
appropriate policies will be taxes (and perhaps subsidies) aimed at assuring that
the full costs (and benefits) of the farmer's actions fall on him.. In the
suggestive language of environmental economics, the tax/subsidy policy would
"internalize the externalities." This has already been done in Iowa, one of the
United States' largest corn producing states, as the state legislature now
imposes penaities on excessive run-offs of fertilizer, pesticide, or erosion from
private farmland.
A final area in which agricultural regulations can be justified on the
grounds of externalities is health and sanitation. It is usually difficult to
trace the source of an epidemic among crops or livestock, and in many countries
it would be difficult to collect from the party responsible an amount sufficient
to compensate the losers. There is thus legitimate reason to regulate, for
example, the import of foreign plants and animals when there is some realistic
chance that they might harbor pathogens. Unfortunately, such regulations have
often been used as devices to restrict imports to protect domestic production
from foreign competition, rather than for their legitimate function; again, a
re-orientation of objectives is in order.
In addition, there are a few cases where the absence of an important market
or political sensitivities may justify (or necessitate) limited intervention.
The importance of food in the budgets of the p or, absence of futures markets
104
in developing countries, and the high costs of insuring small transactions may
mean that it is reasonable to implement well-targeted food subsidies for poor
consumers, meast:res to directly support incomes of poor farmers in ways that do
not distort price signals, and measures to keep price instability from imposing
real hardship and political instability. None of these policies is without cost,
however, and usually the best policies are those that are aimed directly at the
root of the problem, rather than the symptoms. For example, two primary reasons
for the failure of farmers and agroprocessors to insure themselves in
international futures markets may be macroeconomic policies that generate
uncertainty as to the level of the real exchange rate and restrictions on trading
in foreign currencies.14 Here, the best policy woulu be to improve the
macroeconomic and exchange rate policies, rather than trying to create an
alternative insurance scheme by stabilizing prices.
If a developing country government intends to stabilize prices, (perhaps
because the commodity is a basic food staple and a large part of the poor's food
basket) the experience of many countries shows that it is crucial that the
government pursue this goal in a manner that avoids government control and
ownership of the crops. Stabilizing domestic prices by a system of variable
border taxes (and possibly subsidies) instead of by direct procurement makes
the system transparent and predic..able (assuming it operates by well-known
rules). This system also minimizes the possibilities for distortion of pricing
in the distribution chain (i.e., by regulating processing and distribution
14 Small farmers in developing countries, of course, would probably not
use futures markets directly. But the agroprocessors or other lorge-
scale marketers that buy from many producers could be expected to
do so, and would then be able to enter into contracts with the
farmers for future delivery of crops at a guaranteed price.
105
margins). It also eliminates the iesed for the large staff and costly hardware
that are needed to run a procurement program, and so reduces both the
possibilities for corruption and the size of the agency's budget. Another lesson
of experience is that the system should operate under rules that buffer but do
not break the link between domestic and international prices exc^nt at times of
severe instability. The purpose of stabilization is to insure against risks
associated with international commodity price movements. Just as insurance is
only taken out to guard against serious risks, so the stabilization system should
only be used to reduce the largest price fluctuations. Within a fairly wide
band, then, the system should allow domestic prices to move freely, with the
variable taxes/subsidies only bein6 used to buffer the effect of very high or
very low international prices.
Most developing countries clso lack capital markets of a size sufficient
to finance rural infrastructure, such as large irrigation projects and roads.
Consequently, the government may have to carry out such investments. Even here,
however, while the investments must be financed in the first instance by the
government, the taxpayers should not necessarily be forced to foot the bill.
In most or all irrigation projects and some road projects, the beneficiaries are
a clearly identifiable group of users, from whom the costs can be recovered
through taxes or user fees.
Unfortunately, as pointed out in Chapter 3, the legitimate roles of
government in agriculture--especially it..dstment and research--have often been
subordinated to roles for which government bas shown little competence such as
interventions in markets and price setting. These priorities must be reversed
if agricultural growth is to resume. As Box 4-1 points out, there is ample
opportunity to do this.
106
Box 4-2 RESTORING AGRICULTURAL INVESTMENT IN DEVELOPING COUNTRIES:
EXPENDITURE-SWITCHING
Adjustment programs aimed at restoring conditions conducive to growth
often must be carried out at the same time as macroeconomic stabilizasion
measures. For agriculture, this may mean that agricultural public investment
budgets (broadly defined to include expenditure on legitimate public sector
activities aimed at enhancing private sector productivity) should be maintained
or increased in the midst of overall fiscal austerity. One way to do this is
to reduce investment funds going to other sectors, while maintaining or
increasing agriculture's. Politically, however, this may be difficult to do when
each cabinet minister is scrambling to guard his budget. A more politically
palatable alternative may be to reduce agriculture's overall budget, while
switching funds to appropriate investments. This, however, raises the question
of how much room there is to squeeze other parts of the agricultural budget.
In Mexico, one country where good information is available on expenditures,
it is clear that there is a great deal of opportunity to cut other parts of the
budget sufficiently to greatly increase the budget for enhancing productivity,
and even for improving the "safety net" f.r the truly ne3dy. The estimated
expenditures in 1989 in various categories related to agriculture are presented
below:
Millions US$
Credit and insurance subsidies (not volumes) 1,700
Untargeted food subsidies 1,100
Targeted food subsidies 250
Electricity subsidies 400
Fertilizer subsidies 150
Irrigation operating and maintenance subsidies 100
Public investment in irrigation 250
Research and extension 100
Total 4,050
Out of the total expenditures of $4.5 billion, only $0.35 billion went to
growth-enhancing spending (irrigation and research and extension), with another
S0.25 billion going to create a safety net with targeted food suhbsidies (defined
as subsidies with some kind of means test to try to assure they go only to the
poor). About 85 percent of the spending went to untargeted food and input
subsidies. If this part of the budget were cut in half, the budget for
irrigation, research and extension, and targeted subsidies could be doubled,
while still reducing overall sectoral spending by over 28 percent. It is,
however, noteworthy that such decisions could not be taken by the Ministry of
Agriculture acting alone, since much of the spending (around 90 percent) is
outside of its direct control. Such a program would have to form part of a
budget package. But the fact that the package would be expenditure switching
among agriculture-related budget categories should make it more feasible than
if other budget categories had to be raided to support agricultural investment.
107
Source: "Identifacation and Preparation of Sector Operations: Experience from
Mexico a.,d Central America," presentation by Hans Binswanger at RUTA-
IICA Workshop on Identification and Preparation of Sector Operations,
San Jose, Costa Rica, February 23, 1990.
Strengthen-.ng GATT and Agricultural Disciplines
In ':he current international environment, it is unlikely that individual
developed or developing nation governments will have the fortitude to
unilattrally reform their own agricultural support and trade programs. It is
noteworthy that even two strong recent reformers--Mexico and Venezuela--have made
relatively little progress in agricultural (especially agricultural trade) policy
reform. Politically, it is difficult for one government to fully liberalize
its trade in agriculture wnile a major trading partner continues to subsidize
and dump its surplus supplies into international markets, threatening to ruin
the farmers of any country that allows these surpluses free entrance into the
domestic market. But negotiations ijf agricultural policies are less difficult
at the bilateral level or prefer,.bly at the multilateral level. Coordinated
reform simply eliminates the rationale for much of the intervention. One U.S.
farmer said it best in a recent interview (Washington Post, 1990), "Everybody
in the world has farm subsidies and you can lose your shirt to the stroke of a
pen...We can't fight someone's foreign ministry, so we need protection." But
he stands solidly behind efforts to negotiate freer world markets so he "would
be able to compete without worrying about politics."
To have substantial world wide reform take place first requires that the
two strongest subsidizers of agriculture--the United States and the European
Community--agree to reduce or eliminate their subsidization and protection of
108
the agricultural sector. In particular, the US has to give up its Section 22
waiver under the GATT and the EC must substantially modify its CAP, specifically
by eliminating the use of variable levies and export restitutions (subsidies).
In doing this, it must agree that tariffs are the only recognized form of
protection strictly allowed in the GATT and these must be bound at low or zero
levels. If the US and EC can make such a substantial and complete move on its
agricultural policy, the rest of the industrial world will soon follow.
Realistically, to make such a concession in policies requires the type of
negotiating forum offered by the GATT where the political costs of such reforms
can be counter-weighed by the substantial gains in other trade areas, such as
in services or intellectual property rights. That is why the Uruguay Round and
the Rounds of trade negotiation that may follow it are so important.
BOX 4.3: GATT AND AGRICULTURAL TRADE
The General Agreement on Tariffs and Trade (GATT) sets strict rules on
what countries are allowed to do with their trade regimes and with subsidies
for all products that are traded. Governments learned long ago that if trade
is not governed by international rules, trade wars can erupt whereby each country
either dumps their goods at subsidized prices on other countries' domestic
markets or erects higher and higher barriers to trade. This is what happened
in the 1920s and it helped launch the Great Depression. The GATT is supposed
to avoid this possibility by prohibiting certain types of protection (such as
quantitative restrictions and some other nontariff barriers, limiting tariffs
to negotiated levels, and outlawing export subsidies. In this way trade can be
conducted in a largely transparent and fair manner to the benefit of all
countries. Also, with each negotiating session (called Rounds), the tariffs can
be lowered through the principle of reciprocity, whereby one country reduces
tariffs if another country does also. Through the 'Host Favored Nation'
treatment all countries benefit from these negotiations since each party to the
GATT receives the lower negotiated tariff, that is, each country has the right
to receive the most favorable tariff for its trade. Discrimination among trading
partners is prohibited. So far nearly a hundred countries are members of GATT
and are obligated to trade under its rules.
Under the GATT, most trade in manufactures has prospered, with world trade
in 1988 almost six times its 1973 level. Yet agricultural trade has floundered
109
in a morass of protection and export dumping. There has been a gigantic gap
between what countries should do under the GATT and what they actually do.
Unlike manufactured products, agricultural trade has not been liberalized. More
worrisome is that every so often small agricultural trade wars--for example over
pasta or poultry--break out between the major trading partners. Like in any war,
these small skirmishes could explode into major trade conflicts, even to the
extent that they impinge on all trade. This concern has brought the major and
even minor agricultural trade transgressors to the bargaining table in Geneva.
There is great dissatisfaction with this state of agricultural trade and finally
after several attempts in earlier Rounds of trade negotiations, agriculture is
being addressed in the current negotiations in the Uruguay Round.
How did this come about? How is it that this very important bloc of trade
has been excluded from the rules of international trade? First, it should be
understood that the GATT itself does not make any real distinction between
agricultural and industrial commodities in applying these rules except in very
special circumstances (Box 4.4).
The problem has arisen largely becauise under threat of United States
withdrawal from the GATT because of conflicts between GATT provisions and Section
22 of the Agricultural Adjustment of 1935, the United States was granted a waiver
in 1955. The waiver allowed it to use quantitative restrictions on agricultural
imports that may interfere with price supports. Such restrictions have been
applied to a wide variety of products and are still in effect for dairy products,
peanuts, cotton, refined sugar, and sugar-containing products. Others naturally
followed--not through the formality of a waiver--but in strict violation of the
GATT. The EC widely and purposefully controls imports through the CAP and
variable levies. Agriculture is treated differently in the GATT for reasons that
have nothing to do with its laws but because of political imperatives--special
fivors to politically important constituents--and because other countries have
p3rmitted it to continue.
But what about the developing countries? Is it not important that they
also reform their policies? As Chapter 3 pointed out, agricultural policies in
developing countries are also a self-defeating tangle, imposing high costs on
farmers, governments and to some extent consumers. But the current Articles of
the GATT actually give little incentive for developing countries to go along with
world-wide reforms and make substantial changes in their policies. This
reluctance is caused in part by the less-than-full obligations under the GATT
required of developing countries. Unfortunately the waiver of the full
110
obligations for developing countries is not a benefit but a cost to developing
countries. It makes developing countries less than full members of the GATT and
less able to win concessions from their trading partners. It is a situation that
must not continue.
Negotiations in the GATT are based upon reciprocity: one country gives a
trade concession and receives in turn a trade concession from another. Each
party benefits and most importantly all countries receive the trade concession
because of the rule of Most Favored Nation. As a result, world trade becomes
more liberalized. But the key is the reciprocity--one country giving while the
other reciprocates.
BOX 4.4: GATT 'RULES' ON AGRICULTURAL TRADE
One of the most important provisions of the GATT is the general prohibition
of quantitative restrictions on trade (article XI), with a few exceptions:
o Export restrictions to prevent or relieve food shortages;
o Import restrictions for fish and agricultural products when necessary
for enforcing domestic marketing or production restriction programs,
or for eliminating temporary surpluses, provided "that the import
restriction shall not be such as to reduce the total of imports relative
to the total of domestic production"; and
o Import and export restrictions necessary for applying standards to
commodities classification, grading, or marketing.
Export subsidies are prohibited on processed but not primary products,
though countries are advised only to "seek to avoid" the use of export subsidies
on the latter. If such subsidies are used, the Code on Subsidies and
Countervailing Duties requires that countries not apply them in a manner that
will lead to their acquiring "more than an equitable share of world export trade"
or that results in material price undeLcutting. Domestic subsidies are not
prohibited, but the code attempts to regulate the use of domestic subsidies that
would adversely affect the trading interests of other countries. The GATT does
not deal directly with several common agricultural trade barriers, such as
unbound tariffs, variable levies, minimum import prices, and voluntary export
restraint agreements.
ill
Sourcet Ballenger, Doering, and Mervenne
By amendments adopted since the original GATT was negotiated, developing
countries have been "relieved" of the reciprocity obligation through Part IV of
the GATT. This was supposed to be a concession given in recognition of their
less developed status, based on the notion in vogue at the time that import
substitution through trade restrictions was the road to development. In fact,
this 'concession' is a poison and has contributed to developing countries'
extremely protectionist policy inclinations. It is now well recognized that
integration into the world economy is crucial for development. This requires
more open trade regimes in developing countries. But it is also clear that it
is politically difficult to lower trade barriers, since the protected parties
are often better organized to exert political pressure than are the potential
beneficiaries of reform. GATT tacitly recognizes this by treating freer access
to other countries' markets ss a benefit that a country receives in exchange for
incurring the cost of opening its own market. This reciprocity principle creates
a constituency for reduction of protection--tht potential exporters to
counterbalance the protectionist lobby. But by exempting developing countries
from such an obligation, GATT has undercut the incentive for governments to adopt
trade policy reforms that would be in the best interest of their own countries
and the world trading system. Other countries' markets are opened to them
whether or not their markets are ope- to others.
If non-reciprocity were the only loophole for developing countries in the
GATT articles it would be bad enough--but it is not. Unfortunately, there are
more; in fact, others that are more debilitating to developing countries. One
112
is a clause that allows protection of infant industries--another reflection of
the development theories prevailing when the GATT was negotiated. Unfortunately
these industries never grow up and generally have turned into perpetual drains
on their economies. But in particular, Article XVIII, clause B is the kiss of
death. It allows developing countries to institute whatever protection they wish
for balance of payments reasons. This includes even discarding agreements that
they may have made in negotiations where they were forced to give reciprocity.
And hiding behind Article XVIII B is not a temporary expedient. Some countries
have used it for more than forty yearsl South Korea even tried in 1989 to use
it to justify its protection despite balance of payment surpluses in the tens
of billions of dollars.
But the damage caused by Article XVIII B goes beyond the deleterious
effects of excessive protection of domestic markets and the inefficient
industries that this creates. Such an exception means that the agreements that
could be won through reciprocity have little meaning if one party--a developing
country--can obliterate them at any time by claiming balance of payment problems.
It is like signing a contract in disappearing ink. No wonder developing
countries are unable to win trade concessions from industrial countries.
Developing countries are unable to give binding concessions and as a consequence
have nothing to bargain with in the negotiations. They have to come to the Round
with their hand out, accepting only the benefits that trickle down through Most
Favored Nation treatment. Thus, the protection of industrial countries continues
to discriminate disproportionately against commodities of most interest to
developing countries--while developing countries strangle their economies behind
high trade barriers. It is then not surprising to find that agricultural
products which are of particular interest to developing countries are much more
113
discriminated against in trade than industrial commodities produced by developed
countries.
BOX 4.5: THE AGRICULTURAL NEGOTIATIONS IN THE URUGUAY ROUND
The next decade could inzroduce some of the most profound changes in
agricultural policy since the end of the Second World War. For the first time,
agricultural policy has been placed on the agenda of the multi-lateral trade
negotiations under GATT and some agreements are likely to be reached by the end
of 1990. These agreements will most likely prepare the way for a process of
reduced subsidization of agriculture by industrial countries and more liberal
access to developed countries' markets. The implications of these changes for
developing countries could be substantial and their impact could go well beyond
all the development assistance to agriculture of the past 40 years (subsidies
both direct and indirect are estimated to be over $ 200 billion per year). In
other words, the world could be on the brink of profound changes in agricultural
policy. Its implications for food importing countries (net food imports in 1984-
86 stood at $ 27 billion for these developing countries) and agricultural
exporting developing countries (net food exports for these countries was $ 17
billion) could be substantial. And for world agricultural trade in general the
effects could be considerable--possibly with effects comparable to the
liberalization of manufacturing products that accompanied the earlier Rounds of
multi-lateral trade negotiations.
The major issues are direct subsidies for agricultural production, market
access, and export subsidies in industrial countries. However, most proposals
envision that developing countries would have to comply with any agreements on
these issues but on a longer time horizon. In other words, special and
differential treatment would not exempt developing countries, only extend the
time for compliance.
Although the negotiations are intended to be multilateral, in practice
the debate has been primarily between the EC and the United States over specific
trade proposals. The Cairns group has been another major third party that has
influenced the negotiations. While both the EC and the US agree that reduced
subsidization of agriculture is in their own best interest, the extent and the
means for achieving this objective are at odds. The EC is apparently willing
to reduce subsidization but undeL a broad aggregate measure that allows
flexibility in what programs and commodities are selected for adjustments. The
United States wants substantial reduction eventually leading to elimination of
subsidies and tariffication of all border measures, including the EC variable
levy. Japan, another major player in the negctiations, wants the elimination
of export subsidies but the right to support certain crops for food security
reasons.
The primary issue that is of concern to many food importing developing
countries is the impact on their food import bill. Most global models predict
increases in world prices for food as a consequence of full agricultural trade
liberalization. However, these estimates are crude and based in many cases on
114
old data. Furthermore, the liberalization is unlikely to be only partial and
over a long period, ten years or more. This does not mean that the impact may
be minimal: partial trade liberalization especially in certain commodities could
have major impacts on world prices if not accompanied by liberalization in other
areas. For example, lack of liberalization in livestock products while support
for other commodities is reduced or eliminated could synthetically maintain the
demand for feed grains and have a substantial impact on prices for food grains.
Unfortunately, the possible implications of partial liberalization outcomes have
not as yet been researched.
An additional concern is what will happen to food aid. A large inducement
for food aid has been the disposal of excess stocks. If stocks are reduced or
eliminated, food aid may drastically decline. The Food Aid Convention by
establishing minimum levels of food assistance could be a remedy. A renewed and
increased commitment to the Food Aid Convention could help ensure that this form
of foreign assistance will not diminish as a result of an Uruguay Round
agreement.
What Needs to be Done: The Bargain
The dismal state of agricultural policy in the world cannot be separated
from the lack of obligations that developing countries have taken in the GATT.
The development of agriculture is important to developing countries for export
earnings, poverty alleviation, and employment. It is also widely recognized
that industrial development needs the support of a viable agricultural sector.
Reform of agricultural policies on a world wide level is then a prerequisite
for the sustained growth of many developing countries. To bring about reform
requires that agricultural commodities be brought fully into the GATT--that they
be treated the same as industrial products. But for this to happen requires the
full participation of developing countries in the GATT--that is for developing
countries to not only take on the rights of the GATT but its obligations also.
Developing countries have made it known that they demand a solution to the
agricultural problem for them to accept the results of the Uruguay Round. If
they are true to this demand, then the survival of the GATT hangs in the balance.
115
The conclusion of the Uruguay Round of negotiations thus is an ideal
opportunity for a bargain to be struck between the developed and developing
countries of the world. The elements of the GATT bargain would be the following:
(i) Agricultural trade would be made subject to the full discipline of the GATT
by eliminating the waivers and exemptions that have thus far set agricultural
commodities apart from other products in their treatment under the GATT. (ii)
Developing countries would be brought fully into the GATT, by eliminating their
special status that allows them to avoid reciprocity in trade policy reform and
to protect infant industries or use quantitative restrictions for balance of
payments purposes. (iii) All countries would begin reform of their agricultural
policies to reduce the myriad of policy-induced distortions that plague the
sector. Policies that would require reform include import restrictions, export
subsidies, and dumping of surplus commodities by the OECD countries; as well as
subsidies to fertilizer, irrigation and credit which distort trade incentives
in both the developed and developing countries.
This kind of bargain would be a major step in reducing the role of
government in agriculture back to the core functions that it performs best. It
would slow down and eventually reverse the adverse effects that agricultural
policies have had on the environment. It would have the immediate benefit of
reducing the high fiscal costs of current subsidies. This would contribute in
the U.S. to reducing the budget deficit; in the E.C., to reducing the friction
over the budget of the Common Market; and in developing countries, to fiscal
stabilization and to restoring agricultural investment budgets. For developing
countries, undertaking full GATT obligations would lend credibility to trade
policy reforms (which many countries are undertaking, in any case, whether or
not under the auspices of the GATT) and increase their ability to open other
116
countries' markets in the negotiations. In particular, it would improve their
negotiating leverage in products in which they have a special interest (e.g.,
tropical and agricultural products) and add more pressure for reform in those
areas. With fewer trade distortions in international markets, commodity prices
would possibly be significantly higher, and would certainly be far more stable
than at present. This would eliminate the raison d'etre of many of the
interventions in agricultural product markets by developing country governments,
including parastatal involvement in pricing policy and procurement, since these
policies are often intended to protect farmers and stabilize prices. (Erzan
found that many agricultural trade policy restrictions in developing countries
are in response to developed country policies.) The deleterious policies
discussed in Chapter 3 could thus be phased out. With fewer market-distorting
policies, all countries would find fewer reasons to challenge imports on grounds
of dumping or unfair subsidies, and this would reduce agriculture's current role
as an important source of friction in trading relationships. On balance, the
results of such a bargain would indeed be a re-definition of governments's role
in agriculture, increased ectoral efficiency on the national level, and a more
smoothly functioning and tightly knit world agricultural trading system.
117
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PRE Working Paper Series
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